Investing your money into asset classes can be a daunting topic to those new to the process. Here we will explore some of the basic concepts involved.
According to M&G Investments, apart from a lack of sufficient savings, one of the main reasons South Africans do not invest is a lack of basic education on the various investment options available and what each one can do. For many people, this can be a big hindrance to a more prosperous and successful future. In this article, we will unpack what asset classes are and help you understand the various options.
So, what are asset classes?
Asset classes are groups of investments that are similar in nature and are available to the investing public. The most fundamental asset classes are:
- Shares
- Cash (money market instruments)
- Bonds
- Listed Property
The first thing we need to understand is that every financial investment carries some level of risk. Your initial investment amount cannot be guaranteed, and neither can the earnings from it.
Shares
Shares, also referred to as "equity", are securities that are issued by public limited companies and exchanged on accredited stock exchanges. When you make an equity investment, you become a shareholder of the company by purchasing one or more shares. While shareholders are often invited to attend and cast votes at a company's Annual General Meeting, unless you have a very significant shareholding you won't typically be able to affect how the company is operated.
Equities can generate returns in various ways. You can receive income in the form of dividends, which are paid in proportion to the size of your shareholding, typically twice a year, and allow shareholders to participate in a company's performance and profitability. You can also gain capital growth through rises in share price. The payment of dividends is not guaranteed, and there is a chance that the share price will decline below the level at which you made your investment. However, the risk is that a stock investment’s entire value can fluctuate.
Cash (money market instruments)
In order to generate higher rates of return than those normally offered by banks, a cash fund typically invests in money markets and other short-term securities. Cash funds also include some risk because they make investments in capital markets. Investors may not recover their initial investment value, and the income received may also fluctuate.
Compared to bonds or stocks, cash investments are frequently thought of as lower-risk, lesser-return options. For risk-averse investors or as a short-term holding place for money in between longer-term investments, it can be a valuable tool. Cash funds strive to ensure investors' security and liquidity while achieving a competitive rate of return. Generally speaking, they provide low rates of return, which may make them less appealing to investors looking for long-term capital growth.
Bonds
When you buy a bond, you lend money to the bond's issuer and turn into a bondholder. The issuer may be a business, a government, or another organisation. Bonds guarantee to repay the bond's value to investors on a predetermined date in the future known as the "maturity date", and provide a consistent stream of income paid at regular intervals called a "coupon" over a predetermined period of time. Remember that bonds only restore investors' capital if they were purchased at or below par. An investor who spent R301 for a R300 bond won't get his entire investment back.
Although they have historically provided lower returns than equities over the long run, bonds are considered to involve lesser risk and tend to offer more stable returns. There is always the chance that the issuer won't be able to honour its promise to pay coupons to bondholders or refund the bond's face value when it comes due. We call this a default. These occurrences have historically been uncommon, but they do happen occasionally, most notably for bonds issued by corporations as opposed to governments. Bond investments often have a high sensitivity to fluctuations in interest rates, which means that the value of an investment may alter over time. There is no assurance that the issuer will be held liable in the event of a default.
Listed Property
South African property investment is a great long-term investment plan and one of the finest methods to begin building your property portfolio. Investment properties are bought with the idea of making money through either renting the property out, selling it later, or doing both.
Before choosing the type of property (Commercial, Agricultural, Holiday Home, Off-Plan) one wants you need to take into account the difference between all of them and ultimately, the purpose of the investments. Each of these property types is suited to a certain set of requirements and preferences. For instance, new investors should think about the advantages of each form of investment property as well as how challenging it will be to manage them. However, due to its significant potential for economic growth, South Africa is a wonderful location for a wide variety of investment opportunities.
In Conclusion
So, essentially, an investment portfolio can be diversified using different asset classes. Risk can be decreased and distributed by diversification. An investor can select the groups in which to place money thanks to the segmentation of assets into asset classes. These asset classes are designed to weigh risk vs reward and will be explained in detail by your financial advisor.
