Understanding asset classes

The basic building blocks of investment portfolios are the asset classes into which you invest. Each asset class has individual characteristics and carries a different level of risk and return to suit a range of investor types.

Generally speaking, asset classes fall into two main groups – defensive and growth. A diversified portfolio is where multiple asset classes are combined into one portfolio. A balanced fund that is more conservative in its risk return profile may have a higher allocation of assets towards defensive assets such as cash and bonds, whilst a more growth oriented fund would have a higher allocation of shares.

Asset classes

Investment time frame

Risk

Defensive

Cash constitutes investments in short-term money markets and securities. Cash investments can be used as a diversifier or mixer to provide security to volatile or aggressive portfolios, and can also provide a short-term investment solution.

Typical investment time frame of less than 12 months.

While cash is considered the ‘safest’ investment type, investors who invest their money predominantly in cash funds may run the risk over the long term of nominal returns after the deduction of fees and taxes and the impact of inflation.

Bonds (fixed interest securities) are investments in the form of agreements to repay fixed amounts of money at pre-determined dates in the future. Bonds are generally used by governments, banks and corporations.

Bonds typically provide investors with moderate investment returns over the longer term and provide a low-to-medium level of risk for investors

Bonds may be suited to investors seeking conservative investments over the longer term.

Growth

Property includes a number of different types of properties, such as residential, commercial, office, industrial, hotel and retail.

There is a medium-to-high level of risk in a property investment and a medium-to-high level of return. Returns on property can include both capital growth (increase in the value of the investments) and income (rents paid by tenants or distributions paid by the investments).

Property investments are suitable for long-term investors and can provide a higher level of growth without the level of volatility that occurs with share investments.

Shares represent units of ownership in a company. New Zealand shares represent less than a quarter of one per cent of the world’s stock markets, so it is important to consider international shares. Investors need to factor in fluctuating exchange rates to international share investments.

Shares are considered riskier than all other asset classes. Although they tend to provide higher investment returns over the long term, they do experience short-term volatility based on the fluctuations of the stock market and the underlying company’s performance.

Shares are most suitable for long-term investment. Investors need to be prepared to experience moderate-to-extreme highs and lows in order to gain greater investment returns.