The four asset classes, or principal investment markets, are cash (the short-term money market), bonds (the long-term money market), property and equities (the share market). The characteristics of the asset classes are:
Cash is the safest asset class and provides the lowest return over time. It covers such investments as on-call deposits in banks, cash management trusts and similar short-term, interest-bearing investments.
Because cash is the safest investment market, it is used as a benchmark against other investments. When cash rates are low, other investments become more attractive and tend to rise in price. Cash tends to have a low correlation with all other asset classes.
Bonds are also interest-bearing investments, but involve a longer period of maturity, usually some years. Government, local authorities, parastatals, and corporates borrow money from investors by issuing them with debt instruments called bonds. By holding a bond an investor is usually entitled to an annual cash interest payment that is fixed at the time of purchase. While this locked-in interest rate may seem safer, it actually exposes the investor to more risk: if inflation or short-term interest rates go up during the period to maturity, the investor loses out. Bonds are low to medium risk investments and provide low to medium returns over time.
Property covers the whole ambit of real estate investment, from rural estates to office blocks. It is a medium to high risk asset class, with returns proportionate to this risk. Because the property market is generally adversely affected by rises in interest rates, it tends to have a low correlation with interest-bearing investments – especially cash.
Equities are the highest risk, highest return category of investment. Investors take a direct share in the profits or losses of companies, and hence in the economy itself.
An important principle in examining the asset classes is the time horizon and inflation. Although in the short term cash and bonds are somewhat safer, in the longer term they provide less protection against inflation. This means that for long-term investment, they are actually riskier in terms of maintaining real buying power, while property and equities are safer. Tax considerations generally accentuate these factors.
Analysis of South African experience suggests that, over time, the four asset classes are likely to produce the following real (after inflation) returns in the long run:
|Cash:||0 to 1%|
|Bonds:||1 to 3%|
|Property:||2 to 4%|
|Equities:||7 to 9%|
This does not mean that the typical investor should put all funds into shares. Such a move would subject the investor to significant short-term risk, and there is no absolute right or wrong class of investment. The investor’s time frame and objectives are both important in the choice of asset class.
Based on Fortune Strategy – The definitive guide by Bradley, Higgens & Abey