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Different asset classes to consider for investing
Building a portfolio? Learn about different asset classes
Investing is all about making your money work harder for you and generating extra income. The type of investment you select generally depends on two aspects: whether your investment has a short-term or long-term goal, and the level of risk you are willing to take. An asset class is a category of investment and each asset class has different levels of risk and return. Understanding different asset classes helps you determine which types of investments are best suited to your individual goals, needs and investment horizon. Investing is a trade-off between risk and expected return; depending on your risk appetite, you can choose to invest in a combination of asset classes to optimize your returns.
Stocks - Stocks or shares are securities representing ownership in a company. The value of shares normally varies with general economic and industry conditions and with fluctuations in a company's profitability. Thus stocks carry more risk of capital loss than cash and debt as an asset class – though they offer the highest potential investment returns over time, they also involve risk to your principal. Stocks are considered as a long-term investment with an investment horizon of 5-7 years.
Debt/Bonds/Fixed Income securities – Fixed income assets include investment in Bank and Corporate FDs, Corporate or Government bonds/ debentures, etc. They are designed to protect the value of your money over a short to medium term and generally present a low risk of losing the principal amount. These instruments are considered safer than stocks and are suitable for investors with an investment horizon of 1-5 years.
Cash or cash equivalent– Cash assets comprise of near currency assets viz. government bonds, commercial paper, money market instruments, and short-term government bonds that can be converted to hard currency at short notice. These are generally considered relatively safe compared to other asset classes, providing a stable return with low potential for capital loss. These type of instruments are suitable for investors who want to park their funds for a short term i.e. between 1 day to 91 days.
Real Estate/Property – Investing in property generally involves buying a property directly, or investing in property securities or units in a property fund or property trust. Property is usually considered a medium-term investment, with an investment horizon of 3-7 years.
Commodities – Commodities include agricultural products such as wheat and cattle, energy products such as oil and gasoline, and metals such as gold, silver and aluminium. Commodities have evolved as an asset class with the development of commodity futures indexes. Of all precious metals, gold is most popular as an investment and is renowned for its hedge against inflation besides having limited downside risk.
Alternative Investments – Alternative investments are investment products other than traditional investments such as stocks, bonds or cash. They aim to produce positive investment returns under all market conditions. Some of the common alternative investments include hedge funds, managed futures, private equity, venture capital etc. Given their complex nature, alternative investments are best suited for investors who understand the risk-return proposition and other complexities involved with the product.
Why is it important to diversify with asset classes?
By investing in more than one asset class you can diversify your investments and reduce risk. Diversification is an important way to manage the risk associated while investing and entails spreading your money across different asset classes to provide consistent returns overall – underperformance in one asset class can be offset by encouraging performance in another asset class. The intrinsic differences in the nature of various asset classes indicate it is a good idea to combine them in a portfolio in spite of economic and market conditions.
Diversification can help you can stay in control of your investments during market changes and feel secure and confident about your financial decisions. Talking to an expert about your personal financial needs and goals can help you learn more about financial strategies that can benefit you. Contact your financial advisor to learn about investment strategies that suit your needs and take decisions that are right for you.
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