History and experience have shown us that different asset classes and industry sectors generate strong or weak performance at different times.
- Equities have provided the best long-term performance of the major asset classes
- Bonds, on the other hand, are often viewed as medium-to-lower-risk investments
- Diversification spreads your investments across more than one asset class.
History and experience have shown us that different asset classes and industry sectors generate strong or weak performance at different times. For example, equities are widely acknowledged to have provided the best long-term performance of the major asset classes. However, the many investors who lived through the pain of the credit crunch and its aftermath know – only too well – that things can be very different in the short term.
“Many investors find themselves tempted to chase the best returns”
Bonds, on the other hand, are often viewed as medium-to-lower-risk investments, particularly when economic growth is on the wane. Meanwhile, in times of uncertainty, many investors make tracks for the perceived safety of cash – but if you allow your money to languish too long in a deposit account, its real value can fall prey to the corrosive effects of inflation.
The theory runs like this: during periods of strong economic growth, equities are likely to perform well, whereas when economic growth is in decline, bonds and cash should prove more rewarding. In addition, there are "specialist" asset classes – such as commodities and property – whose performance tends to differ from that of the mainstream asset classes. However, specialist and alternative investments require expert advice and should be approached with a degree of caution.
Many investors find themselves tempted to chase the best returns by jumping from one asset class to the next. However, this strategy rarely works in practice. If it were easy to determine when and where to move next, everyone would be rich; in fact, many of the most seasoned investment professionals prefer not to make such risky decisions, believing that any success will be attributable to luck rather than their own skill or judgement.
Therefore, instead of trying to identify the right asset class, and the right time to invest, it is worth considering a portfolio that is exposed to a range of asset classes. This approach is known as diversification: the act of spreading your investments across more than one asset class. This ensures that your portfolio benefits not only from its exposure to asset classes that are performing well, but also from the fact that it is not over-exposed to asset classes that are performing poorly. As a result, your overall investment returns are smoothed out as performance rotates through the asset classes.