- A fund is a pool of accumulated assets. From this pool of assets, investments can be made.
- An example of a fund is a mutual fund. A mutual fund is a financial vehicle that pools capital from investors to invest in securities such as shares, bonds etc.
- Mutual funds are often actively managed, meaning that fund managers actively make decisions about what the fund should invest in, with the goal of minimising risk and maximising returns for investors. They charge annual fees in exchange for this service.
- Although fund managers have discretion to invest as they see fit, they have a responsibility to invest in line with their fund’s investment approach and the best interests of investors.
2. Asset classes
- Asset classes are categories that different types of asset can be sorted into. There are three main asset classes: cash, stocks (also known as shares or equities) and bonds (also known as fixed income or debt).
- Other assets, including real estate and commodities, are referred to as alternatives.
- Choosing which asset classes to invest in is a very important decision for investors – much more important than the choice of a fund or individual investments.
- This is because, while the performance of different financial products within an asset class can vary, asset classes tend to move in the same direction overall. For example, when stock markets are performing poorly bond markets often perform well.
- Certain asset classes are considered riskier than others.
Liquid vs. illiquid
- Liquid assets are assets that are easily convertible into cash. In simple terms, if you want to sell a liquid asset, you’ll be able to.
- In contrast, illiquid assets are more difficult to sell.
- An example of an illiquid asset might be a house. If you live in an area where there is low demand for housing, you might not be able to find a buyer to sell your house to.
- Conversely, stocks are often much more liquid because there tend to be lots of buyers and sellers.
- Cash is considered a very safe asset. If your money is sitting safely in a bank account, you can’t lose it.
- However, inflation eats into the value of cash. This means that, in times of high inflation, it may be sensible to invest your cash into other assets to prevent it from depreciating in value.
- When you buy a stock, you are essentially buying a tiny portion of a business. If the business grows in value, the portion of it that you own will also grow in value, meaning you’ll be able to sell the stock for a profit.
- There are billions of transactions per day in the stock market. This buying and selling is what determines the price of a stock.
- If a stock is in demand and investors are willing to pay more for it than they were the previous day, the price of the stock will rise.
- A stock’s bid price is what buyers are willing to pay (or ‘bid’) for it. The ask (or ‘asking’) price is what the person owning the stock is willing to sell it for. The spread is the difference between these two prices.
What can affect the stock price?
- Stock prices are affected by how investors feel about the prospects a business.
- Positive quarterly or annual earnings reports can increase investor confidence in a business, meaning investors will be willing to pay a higher price for its shares.
- However, negative press can damage investor confidence and lead to reduced demand for the company’s shares, reducing their price.
- A bond is essentially a loan from an investor to a borrower. The investor gives the borrower some money and the borrower agrees to pay it back at a specified point in the future. The investor is incentivised to provide this loan by the fact that the borrower will pay them interest on the loan.
- Bonds are known as a ‘fixed income’ instrument because the interest the investor is paid generally takes the form of regular, fixed payments.
- At the end of the period agreed by the investor and borrower the bond will reach ‘maturity’ and the investor will be given the amount of money they invested back.
Corporate and government bonds
- There are two main types of bond: corporate bonds and government bonds.
- A company or government may decide to issue bonds to raise some money through loans from investors. This money can be used to invest in personnel and infrastructure, allowing organisations to grow.
- UK government bonds are referred to as gilts.
Stocks vs. bonds
- A bond is an agreement between the lender and the borrower. With a bond your return is defined, which means that bonds are considered less risky than stocks.
- When you buy a stock, you’re essentially betting that the company will grow in value in the future. If the company declines in value, the value of your stock will also fall. This means that stocks are riskier than bonds, but the potential returns they can provide are also greater.
Blending asset classes
- It’s possible to invest in multi-asset portfolios that contain various asset classes, such as stocks, bonds and cash.
- Multi-asset portfolios allow for a middle ground between a higher-risk stock-based approach and a lower-risk bond-based approach.
- ‘Alternatives’ is an umbrella term used to refer to assets that aren’t stocks, bonds or cash.
- There are five main types of alternative investment: hedge funds, private capital, natural resources, real estate and infrastructure.
- Most alternative investment assets are held by institutional investors (meaning large organisations) or accredited, high-net-worth individuals. This is because alternatives can be more complex, illiquid, unregulated and risky than stocks, bonds and cash.
- However, they are becoming more popular with individual investors. Our Trends Report explores this in greater depth.