Investing doesn’t necessarily mean the same thing to different people. Every individual will have their own risk profile, and therefore their investable funds will be allocated differently across several different things. In other words, each individual’s investment portfolio will have a different asset allocation comprised of different asset classes.
For example, those with a very risk averse attitude might be more likely to have a larger proportion of their funds invested in in cash or bonds.
Investors with a moderate approach to risk might have a mix of different asset classes – potentially still holding some cash and bonds but with a fair sized proportion of their funds invested in the equity markets (shares).
People that are prepared to take a risk will be likely to have the majority of their investable assets in shares and within this, companies and funds that are considered to be of a relatively volatile nature.
The majority of individuals will also have some money in property – even if this is just their own home.
Most of the time, people will choose their approach to investing, and then simply stick with it. This applies to those that manage their own investments or do so via a financial adviser, although a good adviser should be reocmmendign change as circumstances change.
The issue is that most people simply don’t have time required to spend researching the best investment propositions. This often leads to taking an ‘easy route’ to investing, and sticking with what you know – even if you could potentially be getting a better return elsewhere.
When deciding where to invest money, it is important that investors understand that the best and worst performing asset classes will often vary from one year to the next. This is where diversification comes into play.
With this in mind, let’s take a look at how well different asset classes have performed over the last 30 years…
Using a starting point of £10,000 invested in 1990, the chart tracks the value of different types of investments, giving a value of invested monies right up to the end of 2018.
The immediate thing to notice is the outperformance equity investments have shown compared to lower risk investment environments such as cash, gilts and bonds. Although over the course of the time period shown all three have come out above inflation, the difference between these and equity environments is stark. US equities and Emerging Market equites have been vying for poll position during the 28 year period shown, with US equities eventually coming out on top.
The second point to note is the impact of world events on the different investment types and asset classes. Events such as the collapse of Lehman Brothers can easily be seen on the chart – with a drastic drop in the value of all equity investments. Cash, global bonds and UK bonds, however, remained largely unaffected by this event.
One significant asset class missing from this data is property. The following chart uses data from the Land Registry to show the performance of residential property over the past 28 years. This chart plots the average sale price of all property types across the UK – starting at £58,250 in January 1990 and finishing at £229,681 in December 2018. Soto refer back to the previous chart, for every £10,000 invested in property in 1990, by 2018, you could expect this to have grown to £39,430.
Placed in the context of the previous chart, property would therefore sit between cash and global bonds in terms of its performance. This might come as a surprise – property has been lauded as a big success story for the country over the past 30 years. However, when compared with other investment asset classes, it becomes clear that investing in equities would have proven a far more lucrative route. Furthermore, as an asset class, property has other characteristics that people do not always consider properly when making investment decisions – for example it is very illiquid ie. it is difficult to access your money easily should you need to.
It is worth bearing in mind that this property data does not account for any rental return, mortgage interest payments or any other factor that may impact upon the performance of property over the period being analysed.
Source: Land Registry UK House Price Index
So what does all this mean for investors?
The data here shows that investors who are willing to take a greater risk with their portfolio by investing in equities are more likely to reap greater rewards. The difference between keeping money in cash investing in any sort of equity market is clear. And even when compared to property – an asset class that may people are tempted to invest in – the long-term performance of equity markets far outweigh the gains that can be expected to be achieved from property at face value.
Another key point is that different asset classes behave in different ways – particularly when it comes to large global events. This is why diversification in an asset portfolio is a significant consideration. For a smooth overall investment experience, an investment portfolio should contain a mixture of different asset classes. This allows investors to ‘ride the storm’ if and when a significant global event hits.