Page 106 - DMGT515_PERSONAL_FINANCIAL_PLANNING

Unit 6: Investment Strategies-I

6.1.1 Asset Classes Notes

There are three main types of asset classes – equities, fixed-income, and cash and equivalents.
The three asset classes have different levels of risk and return, so each will behave differently
over time.
Asset allocation refers to the way in which an investor weighs investments in their portfolio in
order to try to meet a specific objective.

Example: If your goal is to pursue growth (and you’re willing to take on market risk in
order to do so), you may decide to place 20% of your assets in bonds and 80% in stocks.
The asset classes you choose, and how you weight your investment in each, will probably hinge
on your investment time frame and how that matches with the risks and rewards of each asset
class.

Risks and Rewards associated with Three Primary Asset Classes

Here’s a closer look at the risk and reward levels of the major asset classes: Stocks. Well known
for fluctuating frequently in value, stocks carry a high level of market risk (the risk that your
investments’ value will decrease after you purchase them) over the short term. However, stocks
have historically earned higher returns than other asset classes by a wide margin, although past
performance is no predictor of future results. Stocks have also outpaced inflation — the rising
prices of goods and services — at the highest rate through the years, and therefore carry very
low inflation risk. Bonds. In general, these securities have less severe short-term price fluctuations
than stocks, and therefore offer lower market risk. On the other hand, their overall inflation risk
tends to be higher than that of stocks, as their long-term return potential is also lower. Money
market instruments Among the most stable of all asset classes in terms of returns, money
market instruments carry relatively low market risk. At the same time, these securities lack the
potential to outpace inflation by as wide a margin through the years as stocks.
Figure 6.1: Risk/Return Relationships

Source: Standard & Poor’s; Center for Research and Security Prices

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