Investment Service Brisbane
What types of investments are available?
There are many types of investment to choose from. Some are perfect for beginners, while others will require advice and experience.
Whether it’s taking a more active interest in our superannuation, starting to build an investment portfolio, or even trying our hands at playing the stock market, we can all benefit by understanding the language and key concepts of investing. Here’s a quick introduction.
There is a huge range of potential investments out there, and these can be grouped together in asset classes that are based on shared characteristics. There are many asset classes, however, the major ones that most mainstream investors focus on are shares (or equities), property, fixed interest and cash.
Shares give investors part ownership (usually a very small part) in specific companies. The share market sets the value of each share and prices can fluctuate significantly, even from day to day. This price volatility means that, relative to other asset classes, shares are higher risk, particularly in the short term. However, investors expect to be rewarded for taking on this risk by the potential for shares to deliver higher long-term gains than the other asset classes. Shares may also provide regular income in the form of dividends. It’s common to split this asset class into Australian and international shares.
Property also provides investors with full or partial ownership of growth assets. Income is received in the form of rent and property also has a strong history of providing capital growth. It is common to further subdivide this asset class into residential and commercial property, as these subclasses can have their own property cycles. As property can, at times, fall in value, it is considered a medium to high-risk asset class.
Fixed interest refers to investment in government or corporate bonds. Bonds are a type of loan, and each bond has a maturity date (the date the loan is repaid), a face value or maturity value (the amount returned at the maturity date), a coupon rate (the interest rate paid on the face value), and a market value. The coupon rate is fixed for the life of the bond (hence the term ‘fixed interest’), but the market value can fluctuate depending on movements in interest rates.
Fixed interest can be high or low risk. At one end of the spectrum are so-called junk bonds, which may offer a high interest rate, but come with a high likelihood that they won’t be repaid. At the other extreme are bonds issued by large and stable governments. These bonds have such a high likelihood that they will deliver the exact return expected by an investor that they are considered, for practical purposes, to be risk-free.
Cash covers bank accounts and term deposits. Returns are in the form of interest payments, and cash is generally considered to be a low risk asset class.
One of the golden rules of investment is that when seeking higher returns, investors must take on a greater degree of risk. As it relates to investment, risk can be thought of as volatility or uncertainty. Quality fixed interest investments provide a high certainty of a particular return. They are low risk, and the returns they offer reflect this. However, for any given share, we don’t know what its price will be in a week, a month or a year. Prices may be volatile, the return is uncertain, so a share is a higher risk investment. However, that risk can be a positive thing – upside risk – which is the potential for the share to generate a higher than expected return.
Asset classes bundle together investments with similar risk and return profiles. By blending these asset classes together in different proportions – a process called asset allocation – investors can construct portfolios that provide levels of risk and return that suit specific needs. Typically, a retiree may want a portfolio that minimises their risk and provides more stable returns. A 30 year old with an investment time horizon of decades may be happy to take more risk, in the knowledge that, over the long term, growth assets (shares and property) have delivered the highest returns.
This blending of different asset classes results in diversification, which is a critical risk management tool. As different asset classes over and underperform at different times, mixing different asset classes lowers the volatility, and hence the risk, of a portfolio.
As far as returns are concerned, studies have shown that over 90% of a portfolio’s performance is determined by the asset allocation. It’s vastly more important than individual investment selection or the timing of purchases and sales.
Why are asset classes important?
Of course, there’s more to investing than can be conveyed on this page, but that’s no reason to delay putting the various markets to work. Your licensed financial adviser can help you understand your risk comfort level, and design an investment strategy that’s right for you.
Make an appointment with Investment Zone to have a conversation about what combination of asset classes would suit your investment profile.