An asset class is the grouping together of assets that exhibit similar characteristics. Traditionally, there are four main asset classes; Cash, Bonds, Property and Equities. Understanding the different types of assets that fall into each asset class is key to constructing your portfolio, as these four asset types exhibit different behaviours and risks and will provide a different return on your investment depending on market conditions.
Spreading your investments across different asset classes is an ideal way to provide diversification within your portfolio.
Cash is generally known as the lowest risk asset class but with low risk comes low reward. Cash held in a bank or building society generally earns only small amounts of interest, especially when bank rates are low. Whilst most investors feel relatively safe by investing their money this way as they don't expect significant losses, in times of low or even negative interest rates return on your investment is likely to be minimal and inflation can even erode the value of cash over time.
Bonds are generally known as low to medium risk assets. Bonds are essentially a loan made to a corporation or government who need to raise capital. In return for lending them money they will a) pay the lender a regular dividend or coupon and b) agree a date when the original capital will be returned. A Gilt is a good example of a type of bond which is issued by a Government. It will usually have a maturity date (e.g. five, ten or 30 years) and promises to pay a fixed coupon rate at set time intervals and a repayment of the loan upon maturity.
Property is a medium to high risk asset. Investing in property is one of the oldest forms of investing. You can invest directly in property by buying a piece of real estate such as a house, an apartment, a piece of land or a commercial building. Most real estate, if kept for the long term, will increase in value or if you rent it out will provide you with a regular income. The risk of owning property is the saleability of the real estate. If sold when property markets are buoyant then you could make a profit, but if you have to sell when the property market is depressed then you could make a loss.
Equities, also referred to as Shares, are high risk assets. When a company wants to raise capital it will issue shares which then gives you part ownership in that company (e.g. Amazon, Apple or the Coca-Cola Company). By owning shares, the investor has the opportunity to receive a share of the company's profits and vote on how the company is run. The value of each share can go up and down depending on how well the company is performing. The risk with shares is that their value can dramatically change very quickly. This could due to a global event which causes a stock market crash or a company-specific announcement, such as a drop in profits. Events like this can cause the share price of a company to plummet leaving the shareholder with shares that are less than the value they bought them for. Equally, if a firm does well, for example they launch a new innovative product, or announce strong profits, popularity in the firm could push share prices up and the share value could exceed what they bought them for. Shares are generally traded second-hand on major stock markets through stock brokers, so the price you pay or receive for shares is dependent on how much someone is willing to pay for them or is willing to sell them for.
Investing across these asset classes
You can choose to invest in these asset classes directly, or you can access them via an investment fund where a professional investment manager does the work for you. There are different types of investment funds whose portfolio will be made up of one or more of these asset classes, such as a Global Property Fund (investing mainly in property), a UK Gilt fund (investing mainly in UK Government gilts), a Liquidity fund (investing cash and cash type assets), a European Equity fund (investing primarily in shares of companies operating in Europe) or a Multi-Asset fund (which as its description implies, invests in assets across 3 or 4 of the asset classes). You can invest in a number of investment funds across various sectors in order to provide diversification.