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Making the big decisions

Peter Westaway, chief economist and head of Vanguard’s investment strategy group in Europe, discusses the main types of financial asset.

 

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Before we can start to construct an investment portfolio, we need to understand a little about the broad types of financial asset. 

My name is Peter Westaway. I am chief economist and head of the Investment Strategy Group at Vanguard Asset Management in Europe. 

The three core types of asset are equities, bonds and cash. Each one serves a different purpose in a portfolio. Cash is for short-term spending; equities are for long-term growth and bonds are to reduce volatility.

Equities have provided the best long-term returns, but they also come with higher levels of short-term risk.

When you invest in equities you are taking part ownership of the companies you invest in. You get your return primarily from moves in the share price – capital growth – but you can also receive income in the form of dividends.

Bonds, meanwhile, are an agreement between a borrower, known as the bond issuer, and a lender, who in this case is the investor.

The investor lends the issuer (typically a government or a company) a sum of money. In return, the issuer agrees to pay the investor a set level of interest over an agreed period – called the coupon. They also agree to return the sum borrowed at the end of the period.

The level of interest paid will depend on a number of factors including the financial strength of the issuer – less financially secure issuers typically need to pay a higher level of interest to attract investors.

Income is the main component of the return in a bond, but the price also fluctuates with market conditions and issuer news flow.

Bonds are less volatile than equities and have produced a lower return over the long term. But they’re more volatile than cash, and have produced a higher return than cash over the long term.

There are other asset classes as well. One is property, which in a fund context usually means commercial property – shops, warehouses, factories. Another is commodities: gold, iron ore, coffee, soya beans and such like.

Some portfolios include a wide range of asset classes. But at Vanguard we believe that most investors will be able to achieve their goals using a sensible combination of the three core asset classes: equities, bonds and cash.

Thank you. 

Investment risk information:

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested. Past performance is not a reliable indicator of future results.

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