When entering the investment world, it is important to be aware of the various types of investments available. Investments that share similar characteristics, such as property and private equity, are grouped together into asset classes based on their levels of risk and reward.
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What Are Asset Classes?
When several investments showcase similar characteristics to each other, they are grouped into a category known as an asset class. These grouped assets are expected to showcase similar risks and returns, be subject to the same laws, and generally perform in the same manner on the market. This is in comparison to separate asset classes, which are expected to perform differently while featuring alternative risks and characteristics. Understanding asset classes and what separates them is a valuable way to make informed decisions when choosing to invest.
Types of Asset Classes
Growth
Growth assets are volatile but have the possibility to generate higher returns over a longer period. Investing in growth assets means your balance is likely to go both up and down over a short period of time, trading stability for more risk and potentially more reward.
Examples:
- Australian and international shares
- Property (listed)
- Private equity
Defensive
Defensive assets typically generate lower returns than growth assets but produce more stable results for a longer period. While they are usually the more dependable investment of the two, defensive assets can still provide negative results. Defensive assets also typically provide returns through income rather than increases in value.
Examples:
- Cash
- Credit income
- Fixed income (bonds)
There are also some types of asset classes that do not fit into either category, instead resembling a combination of the two. These include:
- Infrastructure and real assets
- Liquid alternatives
- Property (unlisted)
How Understanding Asset Classes Helps Diversification
We have all heard the phrase “don’t put all your eggs in one basket” and that applies to investments as well. By utilising the different types of asset classes, you are protecting yourself from one bad investment wiping out all your finances. This is a recommended risk management strategy and a great way to diversify your investment portfolio.
Diversifying your investment portfolio is also more likely to yield higher returns as different investments increase your chances of success while lowering the overall risk. Asset classes tend to follow trends as they increase and decrease in value, which can lead to significant losses if you put all your money into just one class. It is also possible to stretch your finances too thin if you invest in too many asset classes, so it is wise to make less investments with more potential for gain than to make a lot of investments that over-diversify your portfolio.
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As the small and medium-sized business tax accountant that proudly serves the Brisbane area, Taggart & Partners are here for all your professional accounting needs. Whether you require further assistance with understanding asset classes or are looking for ways to minimise tax, give us a call on (07) 3391 1188, send an email to enquiries@taggartandpartners.com.au, or get in touch online.