What are asset classes?
Asset classes are the five main types of investment a fund can invest in:
Cash: - money on deposit (e.g. cash in a bank).
Bonds: - loans to companies or governments.
Property: - bricks and mortar, property equities or REITs (Real Estate Investment Trusts).
Equities: - investment in company shares.
Alternatives: - includes commodities, e.g. gold, copper, water infrastructure and agriculture.
Your fund manager will buy and sell these assets on your behalf, with the aim that their value will increase over time. Each asset class works in a different way and has its own rewards and risks, so it's important to understand how they work before you make any investment decisions.
Cash funds invest in cash deposits, for example, in a bank account, with a rate of interest.
The main benefit for cash investors is safety - it's the safest form of investment.
However in some circumstances, when interest rates are low, the returns on cash funds may be less than the charges on the fund.
Cash funds may not be suitable for long-term investments, because of inflation, which over time erodes the real value of your savings.
For example, if the interest rate was at 0.5%, and the inflation rate was at 3%, then your savings are not earning enough interest to keep pace with the cost of living and therefore your spending power is reduced.
More about risk ratings
A bond is essentially a loan. Many governments and companies borrow money from investors to raise funds and they do so by issuing securities known as 'bonds'. In return for lending it money, the borrower promises to pay a rate of interest in addition to paying back the original loan amount when the bond matures.
Bonds tend to produce lower but more stable returns than higher risk assets such as equities.
There is still a risk these investments could go down in value. There is also a risk that a company or government could default on its debt. Changes in interest rates can also cause the value of a bond to rise or fall.
A good way of diversifying your risk is to invest in a range of bonds from different companies and governments.
Equities are shares issued by a public limited company and traded on the stock market. When you invest in a fund, the fund buys shares in a company on your behalf. .
Equities have the potential to make you money in two ways: you can receive capital growth through increases in the share price, and you can receive income in the form of dividends. Neither is guaranteed and there is always the risk that the share price will fall below the level at which you invested.
Direct investment in a single company can be risky, as you are reliant on just one company to perform well, so buying equities through an investment fund spreads the risk.
This is because equity funds generally invest across a range of various countries, regions, industries and investment styles as a way of diversifying, or spreading risk.
Over time, a fund which invests mostly in equities is likely to offer greater potential for higher returns but with it comes greater changes in value. This is because equities are volatile in nature meaning their value can rise and fall quickly. While they carry the greatest risk, they may provide the greatest return over the long-term (ten years or more).
Investing in commercial property is sometimes seen as an alternative to investing in equities and bonds. As well as aiming for capital growth on the value of a property, rental income is also a source of return.
There are risks and at times, the value of your investments in these funds could fall quite sharply.
Alternatives is an investment that is not one of the four traditional asset classes (Cash, Bonds, Property and Equities).
It can include precious metals such as gold and copper, as well as investments in water infrastructure and agriculture.