Newsletter • Quarter 1 • 2022
Where are your retirement savings invested?
Although our investment decisions are made by professional investment experts, it will give you confidence to have some understanding of how and where your retirement savings are invested.
Across the globe, many different types of investments compete for your savings. Investments with similar characteristics are grouped together into 'asset classes'. The first step in building a successful investment strategy is deciding on the appropriate mix of asset classes to meet specific objectives.
Some traditional asset classes
Equity = ownership
Companies that are listed on a stock exchange offer investors an opportunity to own a portion of that company by buying a 'share' in the company.
This is called 'equity' and exposes the shareholders to both the rewards and the risks. Listed shares are bought and sold on the stock exchange. The price of a share is not fixed but is set by the demand from investors wanting to own a stake in that company and an overview of what the company's earnings and growth may be.
Bonds = interest-bearing loans
A different way to grow savings is to lend them to a business or government (the borrower) for long-term use, with a promise from the borrower to pay back the loan on a certain date in the future.
In return for the use of the savings, the borrower will pay interest to the investor over the period of the loan. These long-term loans are divided into smaller portions, which are called bonds. Much like shares, bonds can be bought and sold on the stock exchange.
However, compared to a share, there are far fewer factors that influence the price of a bond. These factors include:
Money market = cash
Similar to a bond, money market investments are interest-bearing loans to a government, bank or company. The difference is that the money is lent for only a short period (less than one year).
The borrower pays interest on the loan. At the end of the loan term, the borrower returns the capital to the investor. Because of the shorter time frame, the main risk factor is the creditworthiness of the borrower.
Different risk levels result in different return expectations
Bonds and money market investments have more predictable future cash flows than equities. In addition, there is a legal obligation on borrowers to meet their commitment to their investors, resulting in less uncertainty for investors. Less uncertainty means less risk, meaning that investors would be willing to accept a lower potential return over the long term.
Money market investments have a shorter time frame than bonds. The shorter time frame means there is more certainty and less risk. As a result, investors are usually willing to lend their savings for a lower return.
To conclude: traditional asset classes form the building blocks of long-term diversified investment strategies.
