How risky is your portfolio?
Fsp Invest, 13 Aug. 2013
Tags: asset classes, risk, property, reits, speculative investments, speculative, speculative assets, gold, commodities, currencies, collectibles, how risky is your portfolio, portfolio
It’s vital to understand how much risk you take on when you invest in different asset classes. This ranges from low-risk cash in the bank to high-risk speculative investments, such as commodities. Read on to find out what asset classes your investments fall into…
With each asset class you invest in, the risk is different as John Stepek explain in MoneyWeek.
Cash is the lowest risk ‘investment’ you can have. By keeping your money in the bank it’s safe, but if you don’t earn a decent rate of interest then inflation will eat away at it.
Working up from lowest risk to highest risk, the next asset class is government bonds. These are also relatively safe investments.
After government bonds come corporate bonds. These are a little more risky. The risk you take on will depend on the company issuing the bonds.
Equities take another step up the risk ladder.
With equities you can gain a lot with growth, but potentially you could lose your investment.
Let’s have a look at the risks associated with investing in property…
Don’t forget, property is usually bought with debt
Property is a slightly odd asset class.
Unlike a company, the value of a property is very unlikely to go to zero.
It’s not impossible, clearly, but usually you’d expect even the worst property to have some value. So technically speaking, it should be less risky than shares.
However, most buyers of property finance it with debt.
You put down a 10% deposit, say, and borrow the rest. Imagine you put down a R100,000 deposit to buy a R1 million home, with the other R900,000 borrowed from the bank.
When you buy something with debt, you immediately increase your risks.
Say the value of the property falls by 20%.
Your R1 million home is now only worth R800,000. You’re worse off by R200,000.
Not only have you lost 100% of your capital (the R100,000 deposit), you’ve lost another R100,000 on top of that, and you still owe the bank R900,000.
If you now sold the property you’d only get R800,000 for it. You’d owe R100,000 to the bank.
In other words, you’ve lost more than your initial stake.
This is why owning an investment property – when you finance by debt – is actually quite a significant risk for most people.
As for commercial property, the only practical way for small investors to get diversified exposure to this sector is through a professional fund that buys commercial property, or through a stock-exchange-listed real estate investment trust (REIT).
For this purpose, it’s better to view property as a sub-section of ‘equities’, rather than as a separate asset class for your portfolio.
Speculative assets: Not really investments at all
Wine and art (known by investors as ‘collectibles’), commodities and currencies all fall into the realm of speculative assets. You are primarily making a bet on the price rising or falling.
When you invest in them, you need to have a very good grasp of why you think you know better than the market. And you should have an exit strategy firmly in place.
Gold falls into this category.
Look at the asset classes in your portfolio
What assets do you already own? Which of these categories do they fall into? Do a quick review of your assets, and think about the risks involved with them.
So there you have it, the risks of different asset classes. Now you can see how risky your portfolio is.
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