Asset classes are the main types of investments, grouped by how they work and how they tend to behave. The five most common are shares, bonds, property, commodities and cash. Each has a different mix of risk and potential return, and their values often rise and fall at different times. Spreading your money across asset classes (known as diversification) is one of the simplest and most effective ways to manage investment risk over time.

Short answer: If you've heard "make sure you diversify" as investing advice, it really just means not putting all your eggs in one basket. And here's the good news: if you're in a KiwiSaver fund, you're likely to be automatically diversified already. Let's unpack what that actually means for you.

Prefer to listen? This blog is taken from Money Made Simple podcast episode #70, where Jennie and Liv break down asset classes in plain English. Listen on Spotify, Apple Podcasts or YouTube.

What is an asset class?

An asset class is a group of investments that share similar features and tend to respond to the world in similar ways. An easy way to think about them is as the building blocks of investing. There are more than five, but shares, bonds, property, commodities and cash are the ones you'll hear about most. Sorted has a handy overview of the different types of investments if you'd like to know more.

What are shares?

Shares are probably the best-known asset class. You'll also hear them called stocks or equities, and these terms all mean exactly the same thing. When you buy a share, you're buying a small ownership stake in a company. Companies issue shares when they want to raise money to grow.

You can make money from shares in two ways:

1. Growth in value. If the company grows, the share price may rise and you could sell for more than you paid.
2. Dividends. Some companies share part of their profits with shareholders. The company's board decides this, and it depends on the company making a profit, so it's never guaranteed.

Shares tend to have the highest long-term return potential of the main asset classes. The trade-off is high volatility: share prices can move up and down a lot in the short term, especially when the world feels uncertain.

What are bonds?

When you buy a bond, you're lending money to a government (central or local) or a company. In return, they pay you interest and repay the original amount on an agreed date. It's a lot like a loan agreement: you know how much interest you'll earn and when you'll get your money back. You'll also hear bonds called fixed income.

Because of that structure, bonds usually move around less in value than shares, but they also tend to deliver lower returns over the long term. Their prices can still rise and fall, for example when interest rates change.

What counts as a property investment?

Property investments are usually investing in residential or commercial buildings (or land). You can own them directly, or invest through property funds or diversified funds that hold property. Your own home generally isn't counted as an investment in this sense.

Property earns returns in two ways: growth in value (capital gains) and rental income. New Zealand saw strong house price growth for decades, until prices peaked around late 2021. Property cycles also often don't line up with share or bond markets, which is why it can be useful to include in your investment portfolio alongside them.

And how about commodities?

Commodities are the raw materials we use every day, like oil, gold and coffee, traded on global markets. Their value comes straight from supply and demand. They're also driven by different things: oil prices can jump with conflict or economic uncertainty, while crops like coffee respond to weather and growing conditions.

Many KiwiSaver funds don't hold commodities at all. Where they do, it's usually a small slice of a managed fund, added to help spread risk.

Why hold cash if it earns the least?

Cash is the lowest-risk asset class. It offers stability and predictable returns, but it's also likely to deliver the lowest returns over the long term.

Its big advantage is liquidity, which simply means how quickly you can get to your money. Selling a property can take months. Cash is ready to go, which is why it's the natural home for an emergency fund. In a portfolio, cash helps steady things when other assets are bouncing around.

How do the main five asset classes compare?

This is a general guide only. Each asset class can behave differently from year to year.

Why does diversification matter?

Diversification means spreading your money across lots of different investments, so one bad result doesn't have an outsized impact on your investments balance. That spread can work across several different levels: across asset classes (e.g. cash and shares), across companies and industries, and across different parts of the world (not just the US, for example).

Being diversified doesn't mean you'll have a stellar year every year. What it does is help to cushion the bumps. Early 2020 is a good example. When COVID hit, share markets fell by around a third in a matter of weeks, yet some sectors, like technology and parts of healthcare, held up much better and recovered faster. Investors spread across sectors and asset classes felt less of the fall than those concentrated in the hardest-hit areas.

Can anyone predict which asset class will do best?

In short, no. Mercer's Periodic Table of Investment Returns makes this really clear. It ranks how each asset class performed each year, and the order shuffles constantly. An asset class that tops the table one year can sit near the bottom the next.

Ask anyone which asset class will perform best next year (fund managers included) and you might get a confident answer. The truth is they don't know. That's why investing isn't about picking the next winner. It's about building a portfolio that can cope with lots of possible futures.

How can everyday investors diversify?

This part is much simpler than it sounds. One of the easiest ways to diversify is through a managed fund. Investors pool their money into a single fund, and professional investment managers spread it across asset classes, companies and countries. One investment can give you exposure to thousands of underlying investments.

A diversified managed fund can hold several indices at once, covering shares, bonds and property. Either way, you're making one investment and someone else is managing the mix. You can access managed funds through KiwiSaver or through investment funds outside KiwiSaver. For more on how these compare, listen to MMS #81: Shares, managed funds, ETFs - what do they all mean?

Do I need to do anything to diversify my KiwiSaver?

If you're in KiwiSaver, you're likely already diversified (espeically if you've chosen what's called a 'diversified fund', so you can tick that off your life admin list. What could be worth checking is whether your fund type (such as conservative, balanced or growth) suits how long you have until you'll need the money - and your comfort levels with risk. Sorted's Investor Profiler is a good place to start.

TL;DR

• Asset classes are like the building blocks of investing. The main five being shares, bonds, property, commodities and cash.
• Each has a different mix of risk and potential return, and they often move at different times.
• Diversification means spreading your money across asset classes, sectors and regions to help manage risk.
• No one can reliably predict which asset class will perform best next year.
• Managed funds, including KiwiSaver funds, can be a simple way to diversify with a single investment.

Want the full conversation? Listen to Money Made Simple #70 on Spotify, Apple Podcasts or YouTube.

The information provided and opinions expressed in this article are intended for general guidance only and not personalised to you. These materials do not take into account your particular financial situation or goals and are not financial advice or a recommendation. This article is not intended to convey any guarantees as to the future performance of any of the investment products, asset classes, or capital markets mentioned. Past performance is no guarantee of future performance. Information is current at the time of posting, and subject to change without notice. Simplicity NZ Ltd is the issuer of the Simplicity KiwiSaver Scheme and Investment Funds. For Product Disclosure Statements please visit our website simplicity.kiwi.