Do you sometimes lie awake at night wondering what effect the latest share market "correction" or property "boom" or “bust” is having on your investments? Understanding the differences between the various investment assets will help you enjoy better sleep patterns knowing that a diversified portfolio is a good way to manage investment risk.
Money in the bank, a term deposit, or hundred dollar bills stuffed under the mattress - cash is, at face value, the safest, least volatile asset class. The return from cash is entirely in the form of income (interest), which means there is no capital growth. It also produces the lowest returns over the long term, and unless care is taken, the value of cash can be eroded by inflation.
2. Fixed Interest
Next up the risk/return slope is fixed interest. This covers investments such as government and corporate bonds, bills and debentures. Once again, bonds mainly produce income, but because they can be bought and sold, their value can fluctuate due to changes in interest rates. There is also risk associated with the quality of the issuer of the bond. Australian government bonds are considered amongst the safest. At the other extreme, 'junk' bonds issued by some companies are very high risks.
Good old ‘bricks and mortar’ might sound like a 'safe bet', but property is towards the higher end of the risk and return chart. Investors can choose from many different types of residential and commercial property, each with varying risk and return characteristics. The property market is cyclical, and can experience downturns, but it can also provide steady and reliable income, along with good prospects of capital growth when chosen well.
Shares are considered high-risk investments, but they also offer higher returns to long-term investors. Many 'blue-chip' shares also provide income via dividends. As you know, share prices can move up and down over short time periods, causing anxiety for some investors. However, if you invest in the next Google or Apple, the capital growth can be spectacular!
5. Alternative Assets
Some investments don't fit neatly into the previous classifications so portfolio managers may place them into an 'alternative' asset class. This may include infrastructure investments, such as airports and toll roads, and absolute returns funds, which rely on trading strategies for their performance.
By altering the proportion of funds allocated to each asset class, portfolios can be constructed across the full spectrum of risk and return.
How diversified are your investments? Or a better question might be: how well do you sleep at night?
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