This list grades asset classes by risk and return. It may help you if you want to know whether your money is at risk and could be invested better or if you want to become an investor but have no idea where to start.
Investing money can be daunting and it is easy to get attracted to high yields but forgetting about the associated risk. This article aims to shed light on investment risk and returns and help you decide which asset class is right for you.
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asset classes by risk and return
What are the 4 types of asset classes?
People generally talk about four asset classes:
- Money market or cash equivalents
- Stocks or equities
- Fixed Income or bonds
- Real estate or other tangible assets
What are the 6 or 7 types of asset classes?
You may also hear people talking about 6 or 7 types of asset classes which is not wrong either. How many asset classes there are depends on your viewpoint. For the purpose of this article, I break down the types of asset classes much further.
For a concise asset class overview, I have graded the asset classes on a scale of 1 (low) to 3 (high). The higher the number, the better. Please be aware that this is only a very rough guide and should not be the only resource when you decide to invest your money. I am not a financial advisor and this list is for information purposes only.
The areas I am focussing on are
- Asset class liquidity (how easily you can access your money)
- Security (how safe your money is in terms of risk)
- Profitability (return you can expect)
Cash asset class
Cash refers to the notes and coins in your pocket as well as the money in your current account. It is the most liquid form of money as you are able to spend it immediately. On the other hand, it is also the least profitable form of money. You are unlikely to gain anything unless you put your money in high-interest current accounts which often limit the amount you can put in.
Cash as asset class will lose value over time
On the contrary, your cash is likely to lose value over time. This is because of inflation (increase in price levels over time). Inflation is generally estimated at 2.0 to 2.5% per year so if your interest is less than that, you lose money over time. If you have cash you do not need right now, it is better to invest it elsewhere.
Grading asset classes by risk and return, cash is the most secure but least profitable asset class.
Peer-to-peer (P2p) lending
Peer-to-peer lending, often called P2P lending, means that you lend money to other people or companies directly without going through a bank. As bank charges are omitted from the process, investors can earn higher interest from their money and borrows pay a lower interest rate on their loans. Peer-to-peer lending can have many forms that differ in terms of risk and return.
Peer-to-peer lending offers lucrative sign-up bonuses
Ratesetter is one of the more prominent peer-to-peer lending companies and offers the advantage of having its own protection scheme. According to the company, none of their customers has lost money with Ratesetter. Note that this does not mean no one will lose money in the future as there is still no FSCS protection.
However, Ratesetter is one of the less risky options for peer-to-peer lending with solid returns. You can sign-up via my link and bag yourself a £100 bonus when you invest £1,000 (note: this offer frequently changes so check that it is currently available).
Brickowner is another peer-to-peer lending service that I am using. Brickowner lets you invest into properties without going through the hassle of buying and owning a house. This is a slightly more risky form of peer-to-peer lending, but also offers higher returns. You will get a £50 bonus for investing £1,000 if you sign-up via my link.
The liquidity of peer-to-peer loans depends on the availability of a secondary market. Generally, it is quite easy to get your money back but this differs depending on the service you are using.
The advantage of peer-to-peer lending mostly lies in the generous sign-up bonuses that enable you to make enourmous returns e.g. 15% with Ratesetter.
Equity asset class
Investing in equities means you acquire part-ownership of something (e.g. a company) rather than just lending money. This is usually done in the form of shares.
Grading asset classes by risk and return, equities are only slightly less liquid than cash as you can sell shares easily. Buying individual shares is a high risk – high reward game. You may lose all your money but you could also make a fortune. Being on the winning side requires skills and market knowledge.
As the stock market is highly volatile, it offers great opportunities to make money from trading, but again, this requires skills. Beginners are better off investing in other asset types such as index funds which I cover below.
Exchange-traded funds (ETF) asset class
Exchange-traded funds are baskets of stocks, commodities or bonds that are traded on an exchange market like stocks. Due to it being traded, the price of exchange-traded funds can fluctuate throughout the day.
Most commonly, exchange-traded funds aim to track an index, such as the FTSE All-share index, passively. This means that you benefit from market growth while minimising the risk that is associated with investing in the stock market.
ETFs asset class overview
Looking at asset classes by risk and return, exchange-traded funds have high liquidity as you can sell them easily and withdraw your money. In terms of security, exchange-traded funds are less risky than buying shares but also less profitable in the short term. They are not totally foolproof though, as you can still lose money during economic recesses or due to short-term fluctuations.
Asset classes by risk and return – Index funds
Index funds are a similar asset class type to exchange-traded funds, except they are not traded on an exchange. This is also where I have most of my money invested. Index funds hold a basket of individual shares and are designed to track a specific index e.g. the FTSE All-share index. The beauty of this is that you can profit from general market growth and earn passive income.
Index funds capture asset classes in a low-cost and tax-efficient way
Index funds have high liquidity (although they are still less liquid than cash) as you can sell them easily. They are also a low-risk form of investing as, in the long-term, the economy should be growing. Note that this also depends on the specific index you are tracking. However, there is still potential to lose money during market crashes or by choosing a poor index.
Index trackers do not aim to provide sky-high profits, rather you can expect slow but long-term growth.
Index funds are the recommended asset class for beginner investors. Although they are only suitable if you want to invest for a minimum of 10 years.
Bonds asset class
Bonds are loans you can give to the government or companies who need to raise money. In return, the borrower will repay you with interest over an agreed time frame. Bonds play an important role for investors as they are seen as “stabilisers” due to their low risk.
Not all bonds are created equal
Notably, not all bonds are the same and you may be familiar with the term “junk bond”. These are high-risk high-profit bonds that should not be used to stabilise your portfolio. Bonds are given a rating and you probably should not go lower than BBB (adequate) unless you are prepared for a substantial increase in risk.
In general, bonds have high liquidity and are low risk, although this depends on the quality of the bond. However, with a decrease in risk also comes lower profitability than you can expect when investing in stocks.
Property asset class
Property is an asset class that people commonly invest in. If you own your house or flat, you are invested in property. You can also buy a second property and invest in property as a landlord.
As you may know, once you have bought a house, selling it is a complex process. Therefore, properties are not very liquid. They were once seen as a pretty low-risk investment almost guaranteed to increase in value. Sadly, these times are over. Nowadays the property market is less predictable but over the long term, you may still be able to profit.
Investing in property is not mandatory
Investment in property is not easy though, and I would not recommend buying a house just because everyone else has one. Getting on the property ladder is not as important as people may make you believe.
Click here to find out whether you need to own property if you want to become financially independent.
currency asset class
When listing asset classes by risk on return, investing in currencies may seem like a less relevant point. Currencies include foreign currencies such as the Dollar or the Euro and cryptocurrencies. I think currency investment should be considered a gamble rather than an investment as it is hard to predict the market, especially for cryptocurrencies. Plus, to make a meaningful profit, you need to invest huge sums.
Currencies have the advantage that they are very liquid, almost equal to cash. However, this comes at the huge drawback of high risk and probably low return unless you are lucky or very skilled.
Commodities asset class
Commodities include gold, silver, and other raw products and are often sold as “futures”. People commonly invest in commodities to diversify their portfolio and as a precaution for economic crises.
You have probably heard of people who own gold in case of an apocalyptic scenario in which money becomes worthless paper. Is this a good idea? Most likely not but commodities may offer some protection against inflation at the very least.
The liquidity of commodities can vary widely but if you buy wisely, you should be able to get your money back relatively easily. A huge drawback of commodities is the high volatility meaning you could lose money quickly.
Overall, commodities as an asset class play a role in a diversified portfolio but they should not be your main investment. As a new investor, you are probably better off starting elsewhere.
Asset classes by risk and return – Collectibles
The term “collectible” refers to valuable items that can be collected such as paintings, antiques, and wines. For reference, I am heavily biased against using collectibles as a form of investment (but some people do make money with this).
Collectibles as asset class are not for every-day investors
Collectibles are probably also less relevant for everyday investors as you would need to be wealthy already in order to afford to buy these collectibles and cover the additional cost for storage and maintenance.
Just to complete the list: Collectibles are not very liquid as you would need to find a suitable buyer. If you cannot sell your collection, you would have to reduce the prices and may lose money. There is also the risk of damage from fire, floods, etc., or theft.
The key to making money from collectibles is knowing which items will increase in value and what will sell in the future. If you are not an expert in the area, it is better to invest in any of the other classes listed above.
Currencies, commodities, and collectibles are less relevant for beginner investors and chances are that your money is better invested in other types of asset classes.
Asset classes by risk and return Summary
There are 4 asset classes but within them, there are many opportunities and options. When looking at asset classes by risk and return, there is no “perfect” class, usually, you have to make a decision between low-risk or high-return. Hence, the asset class you should choose depends on your unique circumstances and there is no “one size fits all”.
When using my grading system, you have to take into account that a high total number does not absolutely mean that this particular asset class is better than any other. However, it may mean that this class may be worth your consideration.
Above all, the most important rule is: do not act until you are absolutely sure about what you are doing. If you have any questions, you can post in the comments below or shoot me a message.
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