Back in lesson 3, we saw that different assets can perform differently at different times. But what are these assets? And why should they go their own way?

An asset is something you can own, buy, and sell. It’s the opposite of a liability.

• A house that you own is an asset.

• Your mortgage is a liability.

One man’s asset can be another man’s liability.

Your mortgage is a valuable asset for your bank. You’re contractually obliged to pay it back, plus interest.

The main asset classes

Just as the natural world is divided into broad classes like mammals, fish, and fungi – and mammals then divided into cats, monkeys, and many more – the world of assets divides into big groups, with subdivisions.

In investing, these big groups are called asset classes.

The main ones are:

• Cash

• Bonds
  • Government bonds (UK Gilts or US Treasuries)
  • Corporate bonds

• Shares – Also know as equities

• Property
  • Commercial property
  • Residential property (your house or someone else’s)

• Commodities – Especially gold, but also stuff like forests, cows, and oil

• Alternative assets
  • Wine
  • Paintings
  • Stamps

Different asset classes perform differently from each other for two main reasons:

• Economic conditions – Inflation, interest rates, and economic growth affect different asset classes differently, and at different times.

• Emotion – Investors (asset buyers) are by turns fearful and greedy.

Asset classes in (un) reality

Let’s consider a fictitious company: Brixton Unlimited Nappy Services (Stock market symbol: BUNS).

BUNS was founded in 2000 to sell nappies to mums across London.

To raise the money to get started, BUNS floated on the stock market by issuing 100,000 shares at £10 each, raising £1,000,000. These shares can now be freely traded between investors, so the price changes. Each share is a part ownership in BUNS, entitling the owners to a certain share of the company’s fortunes.

Note that only the initially floatation actually invested money into the company.

If you buy ten shares in BUNS from me, a fellow private investor, then no money goes back to BUNS. It’s similar to if you buy a 1930s semi-detached house or a Van Goch painting – no money goes back to the builder or to the artist from these second hand purchases.

Only shares issued directly by the company brings money back to its own coffers.

After a while BUNS wants to expand. It could issue more shares to do so – raising more money by dividing itself up to increase the shares in issue to say 200,000 – but that would dilute existing shareholders and reduce the price of existing shares.

Many BUNS directors are also BUNS shareholders, and they don’t like the sound of that!

Instead it issues 100,000 bonds at £1 each. These bonds promise to pay the owner 10% interest every year for 10 years, at which time they will be redeemed by the company (cancelled) and anyone owning the bonds will get £1 back.

The bond issue raises £100,000. The company spends £60,000 of it on a new nappy shop in Chiswick – an investment in commercial property. It keeps the other £40,000 as cash in the bank for future investment. The annual interest due to the bondholders is paid from the company’s earnings.

After a while, managers get fed up with the price of their nappies going up due to rising raw material costs. They spend £30,000 to buy a special kind of share – an ETF – which tracks commodities like cotton. They hope that if cotton prices go up, reducing profits, it will be partly offset by the ETF price rising, too.

Business goes well, and soon BUNS is making millions. It can easily pay the interest on its bonds and also pay shareholders an increasing dividend.

Eventually success goes to the directors’ heads, and they decide they deserve to work in classier surroundings. They’re also a bit bored of the boring nappy business. They buy several trendy paintings by the graffiti artist Banksy for the office.

They tell shareholders that the paintings are an investment in alternative assets!

Asset classes and risks and rewards

Different asset classes have different risk versus reward traits.

We’ve already seen, for example, how cash is the safest asset class. The riskiest mainstream asset class is shares, but the rewards can be higher, too.

As we saw in lesson three, however, a lot depends on when you buy your assets.

Asset classes or sub-classes can become overvalued as a whole – think Spanish property in 2008 or Dotcom shares in 1999 – as well as undervalued.

But the risk/reward tends to follow this fun graph:

Asset classes and diversification

Note the difference between an asset class, and an asset within that class.

• Tesco and Barclays shares are both assets from within the same asset class.

• Cash you keep in a Barclays bank account is from an entirely different asset class.

Many new investors think they are well-diversified because they have a portfolio of 20 different companies.

But all those holdings are in the same class: Shares!

• Vertical diversification – Splits money between several different asset classes.

• Horizontal diversification – Hold different assets within an asset class.

To achieve a well-diversified portfolio, an investor first splits her money between different asset classes, and then further spreads it around by buying different assets with each sub-division.

For example, allocating 20% of your money to equities gives you exposure to the asset class of shares1. If you put that 20% into a UK index-tracking fund, it is then further spread across the many companies that make up the index. Choose a global tracker fund and it’s spread even more widely.

• Vertical diversification helps protect you from stuff like a stock market crash or a property slump – or from missing gains because all your money is in cash.

•  Horizontal diversification protects you from more local troubles, such as a company making a loss or a bond defaulting on the income it owes you.

The philosopher Francis Bacon had all this figured out 400 years ago, writing:

Money is like muck. No good unless spread.

By muck he means animal manure. Great if spread about to fertilize future crops. A potentially stinking liability if left in a pile in one corner!

Key takeaways

• There are only six main asset classes that you really need to know about.

• Cash, Shares, Bonds, Property, Commodities, Alternative Assets.

• Within each asset class are many different specific assets.

• Good diversification is spread between asset classes, as well as assets.

This is one of an occasional series on investing for beginners. You can subscribe to get our articles emailed to you and you’ll never miss a lesson! Why not tell a friend to help them get started?

1. Note: Equities is just a fancier word for shares. [↩]

I have 26 bank accounts. I never meant for it to happen but it has. Fourteen are current accounts, eight savings, and four are cash ISAs.

That’s not counting the credit cards, broker accounts and other stuff I can’t remember any more.

For a long time it seemed normal. I only realised I was different when it slipped out recently in conversation. One friend said they were shocked.

That’s when I looked at myself in the mirror and I saw what they saw.

I’m a rate tart. I open bank accounts for money. For their competitive rates of interest. Once they’ve outlived their usefulness, I move on to the next. No emotion, no goodbyes, no looking back.

It’s just a transaction, right?

You know you want it

Nobody starts out thinking, “I want a massive collection of bank accounts.” You don’t think to yourself, “Wouldn’t it be great if I was the Imelda Marcos of online passwords?”

You start off small-time:

“I just want to get ahead.”

“I won’t have to do this forever.”

“It’s easy money.”

“Just one more won’t make any difference.”

And it’s so easy to find everything you need to get into it.

A Best Buy table puts you in touch with the right people. Even if you only look at it once a month, temptation soon comes your way.

And if you’re nervous – maybe it’s your first time – there are plenty of old hands out there to show you the tricks. You’ve just got to know where to look.

You open your first account and they pay you a sweetener to lure you in. An extra £100 or so because you’re fresh.

In the early days I was pulling down a few hundred extra quid a year in bounties alone.

But by the time you’re using a spreadsheet to keep track of it all, and standing orders to keep the money moving, and Google alerts so you don’t stay in the same place for too long…

…well, you know you’re not with Virgin anymore.

The rules of the game

I guess a lot of people don’t even know it’s possible to live like this. I read the stories in the papers about people getting 0.25% on their money and I laugh.

It’s not like that where I’m from. I can get you 3%, 4% easy.

It seems like a no-brainer when you put it that way. But not everyone could live the way I do.

There’s a price to pay, y’know? You’ve got to do certain things.

You need a bit of capital for a start.

£1,000 that you move from Peter to Paul – because you’re using current accounts as savings accounts. It sounds wrong, but that’s the way the world is these days. I didn’t make the rules, I’m just showing you how to work ‘em.

So everyone wants a piece of the pie, but you just give them the same old slice and keep it moving through the system so they don’t notice. Or maybe they do notice, I don’t know.

What I do know is: they don’t care.

Some places, the more ‘respectable’ ones, they like to make things harder. They want extras like direct debits on every account.

That’s easy. Just use a feeder savings account that sets up direct debits. There aren’t many, but you can find them, and you just channel £1 a time from one account to the other and back again. It’s like plumbing.

And if someone offers you a complimentary regular savings account – take it. You can get up to 6%! Sure, it’s only on a small bit of money, and they’re not as easy to get now, but you might as well take everything you can get.

Don’t forget cashback. Generally only the Spanish ones are into this, but look, as you get older you can’t afford to be too fussy, alright?

Money for old rope

What most people don’t realise is that you can double-dip. Triple-dip even.

Let’s say you can get 3% from a prospect but only up to £5K. They might allow you to open multiple accounts. Now you can get a good rate on £15K.

And the same people might go by a different name, so you can stash away another £15K.

And maybe they have yet another name. It’s more common than you might think. Everyone’s got something to hide, but that’s another story. Anyway that’s another £15K taken care of.

Just be careful you know who’s who and never trust anyone with more than £85K, no matter how many IDs they’ve got.

It helps if you’ve got a partner. It’s more lucrative if you work in pairs, y’know? You can cover more ground, recommend a friend, all that.

But even that will cost you. After a while, your ‘friend’ may not thank you for dragging them into your world.

Some people worry about their reputation: ruining their credit score and that kind of thing.

You’ve just got to keep your head down. Take it easy and don’t take on the whole world at once.

Keep it as straight as you can. Ditch old accounts when the interest drops… refuse overdrafts, credit cards, rates that are too good to be true, accounts with benefits… Stay away from the weird stuff, keep on moving, and you’ll be okay.

Don’t judge me

That’s pretty much all you need to know. Maybe more than you wanted to know, right?

Am I proud of it? Listen, I blame the Government. I didn’t ask to live in a zero interest world. Funding for lending has only made things harder.

I didn’t grow up dreaming of this. It’s not how I thought things would turn out.

You’ve just got to do what you’ve got to do. That’s it.

The Confessor

Good reads from around the Web.

I miss novels! Sure I can put a tea towel over Twitter, turn the other cheek to Facebook, and watch less funny cat videos on YouTube. That ephemera is easily ignored.

The issue is what my girlfriend calls “side reading”.

I find it impossible these days to read a novel without feeling curious, antsy, or unstimulated, and then reaching for an iPad to look up some bit of detail.

When did the samurai era really end? Can acid dissolve a human body? How close are we to a manned space mission to Mars?

Historical novels, thrillers, science fiction – none of it escapes my Internet-egged-on need to Know Right Now the answer to every question that flutters up.

Perhaps that’s why I found the article on money lessons from fiction posted on Marketwatch so – well – sweet. It’s quaint to imagine learning things from fiction, rather than a blog, a discussion forum, or Khan Academy.

In fact, according to the article novelists warn us that financial bloggers can be downright dangerous:

Don’t expect to find explicit tips on spending, saving and investing baked into the texts like messages in fortune cookies.

Novelists and dramatists seem suspicious if not disdainful of those who dole out advice about money — which is perhaps why, when they do offer worthwhile personal-finance counsel, the words tend to be put into the mouths of imbeciles.

[continue reading…]