Asset categories
When you own an asset it means you have access to the income it generates. All assets are valued based on the income it does or could generate. An empty plot of land in the city cannot be rented out, but the asset still has value as you could put a house on it which would generate income. The price of the land is just discounted by what it costs to build a house. This is known as the highest and best use of the asset.
Assets are claims on cashflows (interest, rent, profits) or on scarcity (raw materials, collectibles). Returns split into yield (income you receive now) and growth (changes in those cashflows over time). Market prices also swing around fair value—those cyclical variations. The PE ratio is the price of the asset divided by the yearly earnings. It essentially means how many years it will take to receive income to match what you spent on the asset initially (at the current rate of return and assuming no growth).
If an asset generates $1 of income and you're willing to pay $10 for it, that's a PE ratio of 10 as after 10 years of getting $1 income you'll have your $10 back.
For some assets income is not stable; rent rises each year as do company profits. If rent went up 10% after a year the $1 income would become $1.10 in year two. With a PE ratio remaining at 10 someone would be willing to pay $11 for your asset now.
Income and PE ratio define the current price.
Income Growth and PE Ratio define the Price Growth.
What defines the PE Ratio? Everything else. When simplified into two concepts: Expected Returns and Sentiment.
If people expect higher returns from an asset because it's risky then they won't pay such a high price. Expected returns rise and fall with the zero risk return of the bank bill swap rate—after all why would you risk losing money if you could get the same return without risk. Sentiment is how we define people being irrational, paying too much or too little for an asset.
Total Return ≈ Yield (today's cashflow) + Growth (change in cashflow) ± Revaluation (price cycle) Revaluation is the change in expected returns and the sentiment.
Understanding how each asset is valued—what's sustainable versus what drives price variation—lets you choose a mix that fits your return, risk, and liquidity needs. While there are an infinite number of different assets, this guide will focus on the seven most common categories.
- Cash — Bank accounts, term deposits. (Yield only; very stable prices.)
- Credit — Secured loans, usually variable rates. (Yield + some spread risk.)
- Bonds — Loans with fixed interest. (Yield + rate-driven price moves.)
- Property — Leasable real estate, often residential. (Rent yield + growth + cap-rate cycles.)
- Equities — Shares in company earnings. (Dividends + earnings growth + valuation swings.)
- Commodities — Materials like gold. (No intrinsic yield; price driven by cycles/scarcity.)
- Speculatives — Non-earning assets (e.g., crypto, collectibles). (Narrative/liquidity-driven.)
Expected Returns
When markets decide what to pay for an asset, they weigh risk against return: the higher the chance of loss, the higher the return investors demand. Risk can be defined and measured in many different ways, in this diagram risk is defined as the plausible 12 month downside you should be prepared to tolerate; the Return % is the long-run total return you'd reasonably target. The RBA cash rate acts as Australia's risk-free anchor—when it rises, investors expect higher earnings from all other assets, and prices adjust so that expected returns step up accordingly.
Risk & Return Characteristics
| Asset Type | Risk Level | Expected Return | Liquidity | Income | Growth |
|---|---|---|---|---|---|
| Cash | Very Low | 3-4% | Excellent | Interest | - |
| Credit | Medium | 4-6% | Good | Interest | - |
| Bonds | Low-Medium | 4-7% | Good | Coupon | Δ Rates |
| Property | Medium | 6-9% | Poor | Rent | Inflation, Δ Rates |
| Equities | Medium-High | 8-12% | Excellent | Dividends | Inflation, GDP |
| Commodities | High | Variable | Good | - | Inflation |
| Speculative | Very High | Highly Variable | Variable | - | Sentiment |
Note: Inflation is just another way to say change in price, or decline in value of money, or increase in supply of money. GDP is the change in economic output of the economy. Growth is always as a result of change in some economics.
Fundamentals: earnings first, cycles second
Fundamentals means pricing an asset by what it can pay you over time, not by short-term ups and downs. Think of it as "what does this thing earn, and how much is that worth today for the risk I'm taking?"
Two parts anchor the price:
- Earnings (often called yield): the cash you get now — interest, rent, or company profits paid out.
- Earnings growth: how that cash can grow in the future.
Where does growth come from at the whole-economy level?
- Inflation: prices rise over time, so the same asset can charge more (for example, rents stepping up each year).
- Real economic growth: often driven by population growth or innovation; which means companies are selling more products at a lower cost, and profits increase.
Revaluation (the cyclical layer)
Even if earnings don't change, prices can still move when the backdrop changes.
- Interest rates: when the RBA cash rate and borrowing costs fall, people are willing to pay more for the same earnings; when rates rise, they pay less.
- Supply & Demand: for investments, supply often refers to the supply of money. Extra money in the system from government spending or central bank policies can push up asset prices.
- Sentiment: booms and busts happen when people get too optimistic or too fearful.
Rate sensitivity by asset:
- Cash and floating-rate loans: prices don't really move; the interest you earn just resets.
- Fixed-rate bonds and fixed-rate credit: prices move with interest rates (the longer the payback, the bigger the move).
- Property: quite sensitive, because borrowing capacity and "cap rates" shift with interest rates.
- Equities: somewhat sensitive to rates, but results vary because company profits can rise or fall at the same time.
- Commodities: mostly driven by supply, demand, and inflation rather than interest rates directly.
Example: Interest rate impact on asset prices
Perpetual Bond
If you spend $100 on a 5% perpetual bond, which pays out $5 every year forever, then interest rates drop to 4%; what would someone have to pay you to own your bond?
They would compare it to a bond which they can buy today; at 4% they would need to buy $125 worth of bonds to get $5 every year. A 25% increase.
New Price = Old Price × Old Interest ÷ New Interest
Property
Residential interest rates are generally 2% above RBA rate.
New Price = Old Price × (Old RBA + 2%) ÷ (New RBA + 2%)
$100 × (5% + 2%) ÷ (4% + 2%) = $116.6. A 16% increase
10-Year Bond
Bonds are not perpetuity investments, they generally last around 10 years. Due to this there is a damping effect on the price impact as you will get the $100 back after the end, not the $125 in the first example.
A rough estimate is New Price = Old Price × (RBA + 10%) ÷ (RBA + 10%)
$100 × (5% + 10%) ÷ (4% + 10%) = $107. A 7% increase
Equities
Equities have a similar relationship, but it's much harder to quantify as other fluctuations occur during interest rate changes which can offset the impact of decreasing interest rates. For example, interest rates are generally decreased when the economy is struggling, which means earnings are probably down already. The drop in interest rate helps improve profitability of businesses as they usually have debt, as well as increasing cash supply to investors which increases sentiment.
Asset Analysis
Detailed breakdown of earnings, growth factors, and valuation variations across asset categories. The numbers displayed in this table are indicitive and for illustrative purposes only, not accurate values.
| Asset Category | Asset Types | ||||||
|---|---|---|---|---|---|---|---|
| Cash | Credit | Bonds | Property | Equities | Commodities | Speculative | |
| Earnings | |||||||
| Base RBA | 4% | 4% | 4% | 4% | 4% | - | - |
| Margin | -1% | 3% | 1% | - | 1% | - | - |
| Expenses | - | - | - | -1% | - | - | - |
| Total Earnings | 3.0% | 7.0% | 5.0% | 3.0% | 5.0% | 0.0% | - |
| Earnings Growth Factors | |||||||
| CPI | - | - | - | 4.50% | 2.50% | 4.50% | - |
| GDP Growth | - | - | - | - | 2.5% | - | - |
| Total Earnings Growth | 0% | 0% | 0% | 4.5% | 5.0% | 4.5% | - |
| Total Sustainable Return | 3.0% | 7.0% | 5.0% | 7.5% | 10.0% | 4.5% | - |
| Revaluation | |||||||
| Interest Rate | - | - | 1/i + 10 | 1/i + 2 | - | - | - |
| Money Supply | - | - | - | - | ±30% | ±20% | ±80% |
| Sentiment | - | - | ±5% | ±10% | ±50% | ±10% | ±100% |
Legend:
- Base RBA: Reserve Bank of Australia cash rate baseline
- Margin: Additional return above/below base rate
- Expenses: Ongoing costs (management, maintenance, etc.)
- CPI: Consumer Price Index inflation impact
- GDP Growth: Economic growth contribution
- Earnings Growth: Asset-specific growth factors
- Interest Rate: Sensitivity to rate changes (i = interest rate)
- Sentiment: Market psychology impact range
Liquidity Management
Liquidity refers to how quickly and easily you can convert an investment into cash without significantly affecting its price.
High Liquidity Assets
- Cash and savings accounts
- Government bonds
- Large-cap stocks
- ETFs
Can be sold within days with minimal price impact
Low Liquidity Assets
- Private equity
- Direct property
- Private credit
- Alternative investments
May take months or years to sell, with potential price discounts
Liquidity Ladder Approach
Maintain a ladder of liquidity: immediate cash for emergencies (3-6 months expenses), short-term liquid investments for planned expenses (1-2 years), and longer-term investments for growth (5+ years).
Risk Management
Understanding different types of risk helps you make informed decisions about your investment portfolio and optimize risk-adjusted returns.
Market Risks
- Market Risk: Overall market movements affect all investments
- Interest Rate Risk: Bond prices fall when rates rise
- Inflation Risk: Purchasing power erosion over time
- Currency Risk: Exchange rate fluctuations for international investments
Specific Risks
- Credit Risk: Issuer defaulting on payments
- Liquidity Risk: Cannot sell when needed
- Concentration Risk: Too much in one investment
- Regulatory Risk: Changes in laws or regulations
Risk Management Strategies
Diversification
Spread investments across different assets, sectors, and geographies
Asset Allocation
Balance between growth and defensive assets based on risk tolerance
Rebalancing
Regularly adjust portfolio to maintain target allocation
Cash Optimization
Cash serves multiple purposes in a well-structured portfolio: emergency fund, opportunity fund, and portfolio stability. However, holding too much cash can significantly impact long-term returns.
Cash allocation strategies
Emergency fund
3-6 months of living expenses in high-interest savings account for unexpected expenses or job loss.
Opportunity fund
Additional cash to take advantage of market opportunities or investment opportunities that arise.
Cash Alternatives
- High-Interest Savings: 4-5% p.a. with full liquidity
- Term Deposits: 5-6% p.a. with fixed terms
- Money Market Funds: 4-5% p.a. with daily liquidity
- Offset Accounts: Effective rate equals mortgage rate
The Cash Drag Effect
Holding excess cash can significantly impact long-term returns. If you hold 20% cash in a portfolio that otherwise returns 8%, your effective return drops to 6.4%. This "cash drag" compounds over time and can cost hundreds of thousands in retirement.
Risk‑ & Liquidity‑Adjusted Return (RLA)
Your optimal sequence depends on your risk tolerance and liquidity needs. Track your personal RLA return—how much progress you make toward goals after accounting for risk taken and cash access required—rather than chasing headline returns alone.
Further Reading
MoneySmart - Develop an investing plan
Six steps to get ready to invest, including setting financial goals, understanding investment risks, and building your portfolio.