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Investing can be confusing and the simple hurdle of trying to understand what is what in investing lingo may actually stop you from taking the first step to a better funded future. Listen to Satrix explaining what asset classes are and how you go about choosing one.
Tim Modise is speaking to Candice Paine. It’s a pleasure to talk to you as we bring yet another Satrix podcast, this time focusing on asset classes and how to go about choosing one.
Thanks for having me, Tim. Yes, the topic of asset classes is always quite interesting because I believe that fundamentally, people don’t understand what they’re investing in, most of the time. Depending on the asset class that you invest in there’s a different return, which you receive for the risk that you take on. The simplest asset class really, is cash in your bank account. You know that it’s pretty much 100 percent guaranteed and you know the interest rate that you’re going to receive on that. If you start moving up the risk spectrum towards bond investing – this would be either Government bonds or corporate bonds – you’re still receiving an interest rate from the underlying investment but now you’re taking on a little bit of risk so you need a longer time period. Similarly, if you invest in equities, which are shares in the stock market, you’re taking on a lot of risk.
We know that the stock market goes up and down and if you look at what’s been happening over the last three weeks in the stock market, we’ve been coming down. People might be nervous that they’ve been losing money but if they sit it out – and this is time in the stock market – over time, the stock market does go up as the economy grows, so it’s about understanding those various asset classes. Another one we haven’t touched on yet is property. When I talk about property, I mean listed property although people need to view their own bricks and mortar home as part of their portfolio. Listed property sits on risk spectrum, somewhere between bonds and equity because it really, is a hybrid product. What you’re getting from that is your rental income, but it’s also a listed security, meaning that it is subject to the vagaries of the stock market and it will go up and down over time. That’s really, what we mean by asset classes.
Obviously, there’s a relationship between potential return and risk when you consider which asset class to invest in.
Yes, there absolutely is. As I said, cash is the least risky of the bunch but the risk that you are facing when investing in cash, is not outperforming inflation. Remember, the first hurdle when you’re investing is that you want to outperform inflation; otherwise, your money is not growing. For example, if your interest rates are lower than your inflation rate – and we’re currently headed into that scenario – then actually, by investing in cash your money’s going backwards. Then you need to consider taking on a little bit of risk, given that you have the time for the value to unlock in those various securities so that you can get an inflation-adjusted return.
Is there any relationship between potential returns, risk, and age at which you start investing?
Not necessarily. You should investing as young as you possibly can and here, I would refer to our podcast on compound interest to understand why. There is wisdom that the closer you get to retirement, the less risk you should take on in your portfolio. That really depends on how much you’ve saved, close to retirement and how much you’re going to draw down. Each individual’s circumstances are very specific and their needs need to be identified on a unique basis, before you can say what risk and return that particular individual will receive.
So, it’s a case of appetite for risk versus the returns that you’re likely to get.
Yes, and understanding the risks that you’re taking on. Everybody wants the big returns but they don’t understand that that comes with risk. For example, in the stock market: often, we only hear the good news stories about the stock market, but the stock market can also destroy value over shorter periods. It’s appetite; it’s your understanding, and the time that you have.
All right, and of course, not forgetting those two other elements – inflation and interest rates – and the bearing they have on the decisions you take.
Absolutely. As we’ve mentioned, you need to outperform inflation, otherwise your money is standing still or it’s going backwards, and then comparing what interest rates you can get for the period you lock your money up for. For example, banks offer things like 32-day notice deposits or six-month fixed deposits. You’ll notice that the longer the time period that you lock your money up for, the higher the interest rate they are willing to give you. That relationship holds true for any investing.
Candice Paine speaks on behalf of Satrix. Thanks very much, again, for talking to us.
Thanks, Tim.
See also:
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Don’t make these investing mistakes – Satrix
What is Financial Freedom anyway? Satrix explains
