Fund managers buy and sell these asset classes on your behalf, hoping that their value will increase over time. The diagram below shows the higher or lower risks attached to the asset classes, and the potential to give higher or lower returns on your initial investment.
Cash funds invest in cash deposits, for example, in a bank account, or short-term (normally less than one year) near cash assets. In some circumstances, when interest rates are low, the returns on cash funds may be less than the charges on the fund. The returns on a cash fund may not keep pace with inflation, and they are not typically suitable for long-term investments.
Many governments and companies borrow money from investors to raise funds and they do so by issuing securities known as ‘bonds’. In return for the loan or bond, interest is paid to the investor until an agreed end date. Funds holding bonds tend to produce lower but more stable returns than funds holding higher risk assets such as equities, but there is still a risk that these investments could go down in value.
There are many different types of bonds, from lower risk government backed bonds to higher risk bonds issued by companies. However, investing solely in bonds for the longer term may result in a lower return than equities. The rate of income on bonds will not keep pace with inflation unless they are index-linked. So, over time, if the rate of inflation is higher than the return generated by bonds, the real value of the bond could fall.
Investing in commercial property is sometimes seen as an alternative to investing in equities and bonds. As well as aiming for capital growth on a property, rental income on property is also a source of return.
At times, the value of your investments in these funds could fall quite sharply. In more uncertain market conditions, it may be necessary to delay your exit from these funds (by up to twelve months).
One of the most traditional ways to invest is to buy shares in a company, which form the asset class more commonly known as equities. Historically, equities have outperformed safer investments like cash and bonds and can act as the real driver for growth in your investment portfolio. Direct investment in a single company can be risky, as you are reliant on the performance of just one company. Therefore, you may want to consider buying equities through an investment fund, which invests in a range of shares in different companies. Equity funds tend to focus their investment on various countries, regions, industries and investment styles as a way of diversifying, or spreading risk.
Over time, a fund which invests mostly in equities is likely to offer greater potential for higher returns but with it comes greater changes in value. This is because equities are volatile in nature meaning their value can rise and fall quickly. While they carry the greatest risk, they may provide the greatest return over the long term (ten years or more).