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.
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.
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.
Other important information:
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