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Asset classes (I): The mainstream
Estimated reading time: 15 minutes

Key takeaways:

  • The 4 mainstream asset classes which form an investment portfolio include: Equities (stocks); Bonds; ETFs; Unit Trusts

  • Among these 4 asset classes, only high quality bonds come with good capital protection (meaning you will not lose your initial investment)

  • These 4 asset classes are designed for longer-term investing, although equities
    are often traded (as regularly as on an intra-day basis)

  • The barriers to entry for these asset classes are far lower today, though bonds and unit trusts have slightly higher barriers (due to minimum investments)

  • Before investing into any asset, it is imperative that you know their characteristics and risks - Do your own due diligence!

DISCLAIMER: The following content represents entirely my own perspectives and opinions  it does NOT constitute any form of product marketing or recommendation, nor does it represent any form of financial advice per se.  

The (hopefully) good stuff that goes into your investment portfolios

It is widely recommended that we should start investing as early as possible, in order for things like the compounding effect to work wonders. 

 

However, there is a long list of asset classes out there, each is catered to different investor profiles – be it age, cash available for investing, risk profile, and other factors. 

 

This article serves to give an overview of the most common asset classes available for us to invest in. 

In doing so, I hope that you can get a clearer picture as to what might be suitable for inclusion within your portfolios, based on your risk profiles and investment objectives.

1.  Equities (also known as Stocks)

Buying stocks is the same as buying a stake in a company or underlying business – you basically own a small part of the company's assets and profits.

 

Typically, equities can be bought and sold through your regular stock brokerage platforms.  Alternatively, placing your funds with professionals (e.g. unit trusts) can grant you access to a basket of equities.

Typically, as a shareholder, you are entitled to benefits such as dividend payouts, company updates, voting rights in company general meetings, and many others. 

 

In terms of growing your money from equity investments, this is primarily achieved through either (a) capital gain (share price appreciation), and/or (b) dividends

 

Generally, there is a trade-off between capital gain and dividends.  Stocks which pay high dividends tend to have lower price appreciation potential.  With more of the company's profits being distributed to shareholders, less is available for their own business activity.

 

On the other hand, companies focusing on growing their business tend to pay less dividends.  These companies retain their earnings, and channel them into investment and business projects, which help drive their performance (and hopefully, their share prices).

 

We should note that dividends are often a test of the underlying company's quality.  Dividends are the clearest evidence that a company has made money – hence, its ability to distribute it to shareholders. 

 

More importantly as well, consistent or increasing dividend payments (along with key financial ratios such as the payout ratio) reflect the sustainability of the company's cashflows and business.

 

Risk level

 

Medium to high. 

 

Some of the factors affecting stock risk level are suggested below: 

 

(I) Company size: Larger, more well-established companies (sometimes known as blue chips) tend to more stable in terms of stock price

(II) Market sector: Certain sectors are typically (but not always) more defensive than others – that is, they can better weather recessions or stock market downturns

  • Utilities, healthcare, and consumer staples are touted as defensive stock sectors

  • Sectors with greater volatility include commoditiestechnology, oil and gas

(III) Geography: Stock prices of companies on larger exchanges (e.g. China, US, Europe) tend to be more volatile, due to there being more buyers and sellers on a daily basis

(IV) Regulations: Related to geography, some exchanges have limits on how far stock prices shift in a day

  • China's equities market has stabilization mechanisms in place – stock prices can increase or decrease only up to 10% on a given trading day.

  • On the other hand, markets such as the US do not have such regulations.  Thus, stock price fluctuations can be higher (e.g. Meta's 24% drop on 27 October 2022)

 

When to invest

 

Given that stocks tend to carry higher risk, it is often recommended to buy stocks in your younger days, while you still have a relatively long investment horizon. 

 

This allows you to focus on wealth accumulation while you have the financial capabilities to do so, in preparation for when you retire.

 

By the time you retire, you would start switching your portfolio to less volatile (or more capital-preserving) asset classes (e.g. government bonds). 

 

In fact, there exists a "Rule of 100", which suggests an inverse relationship between the percentage of your portfolio funds in equities, and your current age:

% of portfolio funds in equities = 100 – Current age

Barriers to entry

 

Generally low. 

 

Some factors which have reduced these barriers include:

 

(I) Low minimum lot sizes today – the minimum capital you will need is also far lower

(II) High liquidity – if a stock isn't working out for you, you can simply sell it away; there normally isn't any "fund lock-up period" per se

  • That said, do take note that some stocks are less liquid than others – especially if these stocks have low trading volume (more on this in a later article)

(III) No significant additional fees (e.g. performance or management fees)

  • HOWEVER, certain types of brokerages may have higher fees than others (e.g. full service versus low-cost brokerages)

  • See my earlier article on pre-requisites for investing for a discussion of this

2.  Real Estate Investment Trusts (REITs)

REITs are similar to equities, except for the fact that you take a cut of profits generated by a REIT manager who uses your money to invest in (and own) properties

 

Investing in REITs is the best alternative to investing in property directly, which carries pretty high barriers to entry (especially if you live in a country with high costs of living). 

 

Similar to equities, REITs can typically be purchased directly through your own regular brokerage platform

A good-to-know is that in Singapore, REITS are legally obligated to pay out 90% of all their profits (derived from renting out their properties) to investors, as dividends

 

It it thus no surprise that the REIT market in Singapore is considered the best in the world in terms of dividend yield. 

 

This also means that investing in a couple of quality REITs can be one source of your passive income when you retire.

Risk level

 

Similar to equities, the risk level for REITs is medium to high, with similar considerations as stocks.  However, a factor particularly relevant for REITs is the local interest rate environment.  

 

Because REITs often take on debt to finance their property acquisitions, higher interest rates may impinge significantly on REITs' profit margins. 

 

However, it is notable that generally, REIT returns and interest rates tend to move in tandem (see the diagram below).

The only notable exceptions in the diagram (see the light blue sections of the graph below zero) were periods where the Federal Reserve increased interest rates as part of monetary tightening, which saw REIT returns invert relative to interest rates.

When to invest

 

A wider investment time frame is possible for REITs, as they represent a potentially great source of passive income for retirement. 

 

Having some REIT exposure in your portfolio even during your retirement years may be good.  But again, a retirement portfolio should not have too much exposure to REITS, as their risk level, like equities, is a bit higher.

Barriers to entry

 

Similar to stocks – generally low (can purchase on regular brokerage platforms without too many additional charges)

3.  Bonds

Bonds are typically known as a fixed income security.  They typically provide income through regular interest payments (or "coupons"), which last for a stipulated period of time (also known as the maturity period).

 

Alternatively, there are also discount bonds, which are sold to investors at a price lower than its "par value" (the amount of money paid to the investor when the bond matures), and redeemed at par value at maturity to provide investors with capital gains

 

For instance, a 2-year discount bond with a par value of $1,000 may be initially sold to investors at, say, $900.  This gives a 11.11% yield to maturity.

Normally, should you be holding on to investment grade bonds or government bonds, keeping them until maturity should guarantee you back your principal (i.e. the initial sum you invested into the bond). 

 

On the other hand, if you are able to sell your bonds at a higher price prior to maturity, you enjoy capital gain on top of any interest payments that have accrued. 

 

Capital gains on bonds are often achieved when interest rates change – specifically, it is when interest rates FALL.  The effect of interest rate changes is particularly large for longer-term bonds (e.g. 30-year maturity).

When interest rates fall, an existing bond’s yield (that has been previously locked in) will become more attractive, and investors are willing to pay more to hold the bond.

 

The main problem with bonds is that they typically require higher capital for entry.  For instance, there are bonds which require a minimum investment of say, $50,000 or $100,000.  

 

Some might even require you to be an accredited investor, which entails pretty steep minimum income and asset value requirements.  For instance, in Singapore, your income for the past 1 year must be no less than SGD300,000.

 

If you are looking to diversify your portfolio into bonds without expending so much capital, you can try Bond ETFs.  For Singapore, Bond ETFs can be bought and sold using your usual brokerage platforms, as they are publicly traded on SGX. 

 

HOWEVER, do note that for ETFs, you will may need additional certification or pass certain assessments before you are able to purchase these assets.

Risk level

 

Low to high

 

The risk level of bonds depends on their issuer, as well as maturity

 

In terms of issuers, unlike equities and REITs, investors also have access to government bonds, which are, most of the time, almost risk-free

 

This is given how it is EXTREMELY rare for governments to simply go bankrupt and default on their debt obligations to their bondholders. 

 

In turn though, the low level of risk to government bonds is reflected in how their coupon rates ​tend to be low (usually 1% to 3.5%). 

 

Meanwhile, at the opposite end of the spectrum, we have junk bonds, which are bonds carrying high risk of default (also known as "non-investment grade bonds"). 

 

The interest rates on such bonds can be as high as 10% or more – the issuer must offer such high returns, as a form of compensation for investors accepting such high risks (of losing their capital).

As for maturity, the longer the time to maturity, the higher the risk carried by the bond.  This is again reflected in how longer-term bonds offer higher interest rates

 

With longer terms to maturity, bonds are exposed to greater price fluctuations, brought about by interest rate changes, and bond ratings.

When to invest

 

Any time.  

 

Bonds typically feature more in portfolios during your later years (including in retirement).  However, for younger investors, higher-risk bonds and non-government bonds can be incorporated into their portfolios.

Note that during market downturns, investors typically shift away from equities into bonds, given how bonds have greater safeguards than equities (in terms of their capital guarantee at maturity).

Barriers to entry

 

Medium (higher than equities and REITs).

The primary reason for this is that investment capital requirements are more stringent for bonds.  As I already shared above, for instance, some corporate bonds tend to have minimum investment requirements of $50,000 or $100,000.

The exception would be government savings bonds (or in the US market, "T-bills"), with low minimum investment amounts such as $1,000 that make them accessible to the general populace of retail investors.

If you wish to circumvent this problem of high capital outlay requirements, you can choose to invest in Bond Funds or Bond ETFs (I will explain ETFs and mutual funds further down in this article).

Another issue is that there are many different types of bonds, which can make them complicated to understand. 

 

While the following article does not touch on all types of bonds, as a reference, you can refer to the following site for a snapshot:

 

https://www.sc.com/sg/wealth/insights/types-of-bond-you-should-know/

4.  Exchange Traded Funds (ETFs)

ETFs are often regarded as a cost-effective way to diversify your portfolio.  In fact, diversification is pretty much free when you buy into an ETF.  

 

An ETF works by mirroring the stock holdings (and their relative proportions) within an underlying market exchange Investing in ETFs essentially means that you are investing in each of the component companies which make up the exchange tracked by the ETF. 

 

For instance, by buying the Straits Times Index (STI) ETF, you will effectively own a bit of each of the 30 companies included on the STI.

By extension, because ETFs typically mirror an underlying market index, their performance will also very closely mimic the market (albeit slightly lower, due to management fees).

In other words, you will not be able to outperform the market, but you will be able to benefit from the overall growth of the market (which, in many cases, can already soundly beat inflation).

Risk level

 

Medium to high.  

 

ETFs can track a vast array of market indices.  Bigger market indices (e.g. the S&P500), or indices concentrated within a certain sector (e.g. Tech) tend to be more volatile. 

 

For instance, looking at the price chart below, the iShares Hang Seng Tech ETF (HKEX: 3067) has, as of 2023, fallen more than 60% from its last high price of about 22 yuan.

However, a consolation is that it is next to impossible for you to lose your entire principal investing in ETFs – because it is also almost impossible for the entire stock market's value to fall to 0.

 

At the same time, because ETFs include a basket of stocks (typically at least 10), by the principle of diversification, there is significant reduction in firm-specific risk

When to invest

Any time, as long as you are seeking cost-effective diversification, and to capture broader market movements, without having to self-select the stocks for your portfolio. 

 

However, typically, younger investors with longer investment horizons and higher risk appetite are positioned to reap greater gains.

 

If you would like to have some exposure to higher-risk asset classes in your older years without having to deal with firm-specific risk, ETFs may be your answer too!  Just remember that depending on what index it tracks, ETFs can be moderate to high risk.

In relation to bonds, bond ETFs represent a way to circumvent the high capital requirements for investing into individual bonds.

Barriers to entry

 

Medium (higher than equities/REITs, but not as high as bonds),

(I) ETFs are considered a structured investment product, which means that you may need to have some experience and/or knowledge of these products first.

  • If you haven’t got these prerequisites, you may be required to take a short course or 2 to certify your knowledge, before you are able to invest. 

  • Other than that, ETFs can be bought and sold directly using your regular brokerage platforms

(II) ETFs come with some additional fees (management fees / expense ratios).

  • Prior to investing into an ETF, do search up these fees, because, as I previously showed, even a 1% difference in fees can SERIOUSLY chip away at your returns over time.

5.  Unit Trusts (UTs) / Mutual Funds (MFs)

While UTs and MFs are not completely the same, the main idea behind them is pretty similar: by investing in these assets, you pool your funds with other investors.

 

With this large pool of money, the fund/trust manager will invest your money according to the trust/fund's investment objective. 

 

UTs and MFs similarly provide you with diversification, except that this diversification is achieved through active management

 

This is to say that a team of analysts and a fund manager will regularly move the pooled funds in and out of different self-selected assets, based on prevailing market conditions, in order to continue meeting the mutual fund's investment objective and risk levels.

The good thing about UTs, compared to ETFs, is professional management.  While, to be fair, it is difficult for a certain UT/MF to constantly outperform, there are several more well-known managers who have produced more market-beating UTs.

Last but not least, when funds are pooled and invested in the millions, both yourself and the fund manager will enjoy economies of scale – that is, the per-unit cost of investment is lower, due to investments being made in bulk.

Risk level

 

Low to high

 

There is a wide variance in risk levels for UTs/MFs, based on:

  • Investment objective of the fund

  • Geographic focus of investments

  • Sectoral focus of investment

  • Asset types included within the portfolio

Typically, on the platforms to invest in these funds/trusts, you are able to filter your choice of UTs/MFs (e.g. according to your risk profile, and sectoral/asset focus - see image below).

Unit Trust screener (by DBS), allowing for selection of aspects such as risk level, asset classes, geographies, etc.

When to buy

 

Younger years

 

Primarily because (as I highlight below) UTs tend to have higher one-off fees, and potentially even penalties for early withdrawals of funds. 

 

Usually, to break even on one's investment, one will need to stay invested in the UT for at least 3 to 5 years, some even longer.

Barriers to entry

 

Medium (higher than equities/REITs, but not as high as bonds).  

  • UTs/MFs typically carry higher management fees than ETFs due to typical active construction of portfolios

  • At the same time, there may be other charges, such as penalties from withdrawing one's funds early (this incurs additional costs on the fund managers)

  • UTs/MFs may not be purchasable on your usual stock brokerage platforms – there may be dedicated or separate portals/sites to do so

  • Potentially lower liquidity: Some funds/trusts have lock-in periods, as well as corresponding penalties for switching out too quickly

Conclusion

This article has introduced you to the most common asset classes for investors. 

 

With the myriad types of assets one could add to one's portfolio, it is thus crucial that one knows key features of each asset class, such as risk level, barriers to entry, and for whom it is most suitable.

This will assist you with portfolio planning and monitoring – a key step to controlling the risks to your invested capital.

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