Allocating Assets to Help Mitigate Investment Risk

You may have heard the saying,

"Don't put all your eggs in one basket."

That's because you risk breaking all your eggs if the basket falls. And this analogy of risk applies to many aspects of life.

For example, when it comes to investing, we may implement the idea by investing in various asset classes and investments to manage risk.

In this way, a losing investment is less likely to disrupt your entire portfolio.

So what are some common asset classes? And what are their characteristics?

Stocks, mutual funds, bonds, properties, gold, forex, and cash are some of the common asset classes.

Let's look at some different characteristics of these assets in terms of return, risk, and liquidity.

First, stocks.

Many investors go for stocks.

This asset class is generally considered a high-risk investment with the potential for high return.

Most stocks have good liquidity, but some are not that liquid due to low demand.

If we take a long-term perspective, stock prices are based on the underlying company's profitability.

In the short term, the market demand and money supply can also impact prices.

Second, mutual funds.

Mutual funds are a type of asset managed by professional investment managers.

We can divide mutual funds into different groupings like equity funds, fixed-income funds, money market funds, and balanced funds based on the assets they invest in.

Investors buy shares of the mutual fund which invests in multiple securities. This allows investors to have exposure to the risk and returns of several securities just by owning shares of the mutual fund. Different mutual funds tend to have distinct risk and return profiles.

They differ in liquidity as well. For most mutual funds, it's easy to subscribe to or redeem shares. But there are close-ended funds that cannot be redeemed until years later.

Third, bonds.

Bonds represent the debts of issuers, such as companies or governments.

The interest rate or coupon rate and the price difference are two determinants of a bond's return.

The coupon rate is related to the issuer's creditworthiness.

For example, government bonds offer lower coupon rates than others since the governments generally have the lowest credit risk.

Bonds' prices, on the other hand, are affected by the prevailing interest rates. Generally, lower interest rates make bonds more attractive.

But bond investing involves risks, too.

For example, issuers might default on paying coupons or principals, and bonds may be traded at a discount.

When it comes to liquidity, Bonds with better ratings tend to have higher liquidity.

Fourth, properties.

Properties purchased other than your principal residence can be called investments.

Risk and return of property investments can be affected by economic growth, demographic shift, and location.

But if your real estate investment is with leverage, it may generate investment growth but expose you to higher risks as well.

However, since there's no integrated market in place for property trading, coupled with high acquisition costs and time-consuming transaction processes, real estate is considered an illiquid type of asset.

Fifth, gold.

Here we mainly talk about physical gold. It is generally considered a hedge against inflation due to its low correlation to other assets.

Gold's return mainly is correlated with the dollar value, inflation level, and geopolitics.

Generally, demand for gold rises with a weak dollar, rising inflation, and increasing geopolitical tensions.

As gold's value is widely recognized, it is also a liquid asset.

Sixth, forex, or foreign exchange, which refers to buying and selling the currency of another country.

Forex's risk and return are affected by the exchange rate of the two currencies traded.

If the domestic currency weakens against the foreign currency, the foreign currency you hold will go up in value.

On the flip side, if the domestic currency strengthens, the foreign currency will decline in value.

Generally, the more open the capital market, the higher the liquidity.

A currency's value, in the long run, depends on the country's economic growth. In the short run, it is influenced by the current monetary policy and the supply and demand.

Seventh, cash.

This asset is generally considered the safest.

But in a low-interest rate environment, its return is generally far from satisfactory.

The strength of cash lies in its liquidity. It is the most liquid asset of all and is indispensable for our daily life.

We've walked you through the characteristics of seven major asset classes. You can start building a diversified portfolio based on your financial situation and risk tolerance.