If you’re interested in building wealth, it’s important to understand all your asset classes, because life isn’t just about investing in property.
It’s an important point to make in the current climate, where interest rates remain at record lows, household debt levels are climbing and a level of uncertainty is plaguing consumer confidence.
The Reserve Bank of Australia decided to keep the official cash rate at 1.5 per cent on Tuesday, for the 12th month in a row.
In doing so, the RBA also flagged that it was still concerned about property price growth given most Australian’s just can’t get enough of bricks and mortar assets.
But in case you didn’t know it, there are four asset classes available and they include: cash, fixed interest, shares and property.
Cash and fixed interest are called defensive investments, while property and shares are growth investments.
With rates remaining so low, and regulators tipped to tighten lending requirements even further, it’s good to understand how other asset classes work.
Cash includes bank accounts, cash management trusts, and the cash you have in your wallet or purse.
Generally, cash is the most “liquid” investment type because it’s money already.
You can increase or decrease it instantly through deposits and withdrawals.
It also gives some peace of mind that it won’t rapidly decrease in value from something like a share market crash or a bursting property bubble.
However, it will lose its purchasing power over time due to inflation.
Fixed interest investments are a diverse investment category, and include term deposits, government bonds, corporate bonds and debentures.
These are often called income securities.
With most fixed interest investments, the interest rate and timeframe for investment are set from the outset.
A term deposit is like a normal bank savings account, except your money is locked away for a fixed time.
You earn more interest than in your bank account, but in return you lose the flexibility of having access to your money.
With government bonds, you lend money to the government for a specified time, and get paid interest in return.
If you hold this investment to maturity, you will get back your capital as well as your interest.
Government bonds have the security of being backed by the Reserve Bank.
Corporate bonds are similar to government bonds, except you’re lending to a public or private company rather than to the government.
This comes at a higher risk because your investment is not guaranteed by the Reserve Bank.
If the company goes out of business, you might lose your investment.
Secondary bond market
If you hold a government bond, you can sell it to another investor before it matures.
On the secondary market, the coupon remains fixed but the value of the bond changes to reflect the current market conditions.
If interest rates are rising, bond values go down, and vice versa.
This means you can make money from bonds in two ways: from the interest and from growth in the capital value of the bond.
Property is a popular investment in Australia.
Property can provide you with an income return, as well as capital growth.
This return depends on a number of factors, including location, type of property, rent, and quality of tenants.
Shares represent part ownership in a company.
When you invest in shares of a company, you’re buying a share of the company’s income and growth.
Some traders invest for the short term, but most invest for the long term.
Because shares are traded daily, they are more volatile than property.
Australian shares are a relatively liquid investment however if the share price is falling there may be a limited number of buyers.