What is an investment asset class?
Learn the difference between defensive and growth assets and how these affect your investment portfolio.
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Once you start thinking about investing, you'll hear the term "asset class" come up a lot. Simply put, the asset class refers to a group of assets or investments which are similar in nature. It's important to understand the difference between the main asset classes when building your portfolio as it will affect your investment returns and the level of risk you're taking on.
As well as explaining the different asset classes in this guide, we'll give you some tips for how to choose your mix of assets when building your portfolio. You can also compare online trading accounts to start investing in the share market.
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What are asset classes?
Asset classes are groups of assets that have similar qualities, for example shares (also known as equities). There are lots of different types of equities; you can invest in Australian shares, international shares, blue-chip shares, shares from emerging markets like India, industrial shares, technology shares and resources shares.
While these are all different types of shares, they belong to the same asset class because they're very similar in nature. They're all bought and sold in the same way via an exchange and they all have the same tax implications. They're also regulated in the same way.
What are the main asset classes?
There are five main asset classes.
Equities include all shares listed on a public exchange, for example shares listed on the ASX or the NASDAQ in the US. These are publicly listed companies and when you buy shares in these companies you own a portion of that company. Equities are often considered to be the highest-risk asset class.
Fixed interest assets are those which offer a fixed rate of return, for example bonds. Bonds are essentially a form of loan used by both companies and also governments when they need to borrow money. Investors who lend their money will earn a pre-set, fixed interest rate on that money.
This includes property investments in residential homes as well as investments in commercial property like major offices or industrial buildings. This is known as unlisted property, as it's not bought and sold on an exchange like shares are.
However, you can also invest in listed property in the form of a managed fund that invests in a range of properties. Although you do access listed property via an exchange, it's still considered part of the property asset class, rather than equities.
Alternative assets are harder to identify, but they typically include assets that don't fit into any of the above asset classes. For example, private investments made into a private company (one that isn't listed on an exchange) would be classed as an alternative asset. Another example is collectibles like antiques, art or even an extensive stamp collection.
Commodities like gold and precious metals are sometimes included in the alternative asset class and sometimes they're referred to as their own asset class.Back to top
Defensive vs growth assets
These five asset classes can be further grouped into either defensive or growth assets. Defensive assets are lower risk and often offer investors a level of guaranteed income, for example interest payments. Growth assets on the other hand are riskier and typically aim to achieve capital growth over the longer term rather than income over the short term.
While returns are never guaranteed, it's expected that high-risk growth assets will outperform lower-risk, defensive assets over the long term.
- Fixed income
- Alternative assets
Investing for income vs capital growth
You could also divide the assets up depending on whether you're investing for income or capital growth. Income assets are those which provide an ongoing level of income while you hold the asset. Capital growth assets may not provide any income for the short to medium term, but the investor hopes the asset itself will grow in value so that when it's sold, they'll make a profit. Antiques are an obvious example here.
One asset class can include both income and capital growth assets. Let's look at shares as an example. An established blue-chip share like BHP or Commonwealth Bank that makes a profit every year and consistently pays a large dividend to its shareholders would be classed as an income asset, as it offers value while you're holding it. However, shares in a newly-listed technology startup that pay no dividends would be classed as a capital growth asset, as the shareholder buys it with the hope it will increase in value over the longer term.
What does the term "underlying asset" mean?
You'll often hear the term "underlying asset" in relation to some investment products like exchange traded funds (ETFs), listed investment companies (LICs) and derivatives like a contract for difference (CFD). These products all track the value and performance of a particular set of assets, known as the underlying assets, often without owning that asset.
Let's look at ETFs for example. These are a type of fund that tracks the performance of a basket of assets, often shares, belonging to a market index. So an ASX200 ETF will track the ASX200 index, which is the value of the top 200 companies listed on the ASX. If you invest in the ETF, you'll get exposure to these 200 shares (the underlying assets) without actually owning any of them directly.
Why should you invest in a range of asset classes?
Each asset class offers a different level of risk and the different asset classes aren't affected by the same market conditions as each other. This means factors that might make share prices fall or rise could have little impact on other asset classes like cash and property. Because they rise and fall at different times, investing in a range of asset classes will make your portfolio a lot less volatile.
Investing in a range of asset classes will make your portfolio more diversified, which is a key way to reduce your risk. If you're only invested in equities and share markets around the world crash, the value of your portfolio will fall a lot. But if half your portfolio was invested in another asset class like cash or property when the share market crashes, the value of your portfolio wouldn't be as badly impacted.
How to find the right mix of assets for your portfolio?
When designing your portfolio, take the following factors into consideration when deciding which asset classes to invest in.
- Your age. The younger you are, the more risk you can afford to take on because you have more time to ride out any market falls.
- Your risk tolerance. Regardless of your age, if risky assets are going to keep you awake at night it might be best to invest in asset classes that are lower risk.
- Your goal (income or growth). Why are you investing? Do you want to earn a regular income stream now or are you investing for way into the future?
Now that you understand the different asset classes, if you're ready to start building your portfolio you might want to check out our seven-step guide to buying shares online.
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