Asset Class—What Is It?
A group of investments with similar characteristics and laws and regulations is an asset class. Thus, asset classes contain instruments with similar market behaviour.
Equities, bonds, commodities, and real estate are asset classes.
KEY PHRASES
- A group of investments with similar characteristics and laws and regulations is an asset class.
- Asset classes include stocks, bonds, cash, cash equivalents, real estate, commodities, and currencies.
- Asset classes rarely correlate, sometimes negatively.
- Financial advisors help investors diversify by asset class.
Classifying Assets
Asset classes are groups of similar financial securities. IBM, MSFT, and AAPL are stocks. Asset classes and categories are often confused. Asset classes rarely correlate, sometimes negatively. Investing requires this trait.
Stocks, bonds, and money market instruments have traditionally been the three main asset classes.
Most investment professionals include real estate, commodities, futures, financial derivatives, and cryptocurrencies in their asset class mix.
Investors buy and sell tangible and intangible assets for short- or long-term income.
Financial advisors consider investment vehicles asset-class categories for diversification. Each asset class has different risk and return investment characteristics and performs differently in any market environment.
Asset class diversification reduces portfolio risk for return-maximizing investors.
Financial advisors help investors diversify by combining assets from different asset classes with different cash flow streams and risk levels.
Diversifying across asset classes ensures investment diversity. Diversification lowers risk and boosts returns.
Asset Classes
Main asset classes:
Cash & Cash Equivalents
Cash and cash equivalents are cash and similar securities. This investment is low-risk because you won’t lose money. Peace of mind lowers returns.
Cash and cash equivalents include money market funds, T-bills, GICs, and savings accounts. Risk increases return.
Fixed Income
Fixed-income investments pay a fixed income. You lend money to an entity, which pays you a fixed amount until the maturity date, when they repay the loan.
Most fixed-income products are government and corporate bonds. Depending on inflation and the perceived risk of default, the government or company will pay you interest for the life of the loan.
They pay less because governments rarely default on their bonds. Some companies risk bankruptcy and must pay investors more to attract them.
Equities
Equities are usually company shares. Companies sell ownership stakes to the public to grow and achieve their goals. Buy these shares to profit from a company’s success.
Two ways to profit from company investments:
Company Dividends
Selling shares for more than you paid for them
Markets can be volatile. Share prices fluctuate, and some companies fail.
Commodities
Commodities can be used to make other products. Metals, energy, and crops are examples.
Commodities help the economy and can hedge against inflation. Supply and demand determine their return, not profitability. Investors buy shares in commodity producers to indirectly invest in commodities. However, direct investing—buying a physical commodity to sell later or investing in futures—is also a huge market.
Each asset class has a different risk-return profile and performs differently in different environments.
Other Investments & Asset Classes
Stocks, bonds, marketable securities, and commodities are the most liquid and quoted asset classes.
Real estate and valuable inventory like art, stamps, and other collectibles are other asset classes.
Some analysts consider hedge funds, venture capital, crowdsourcing, and cryptocurrencies alternative investments. However, an asset’s illiquidity doesn’t affect its return potential—it just takes longer to sell.
Class and Strategy
Alpha investors use alpha-focused strategies. Growth, value, income, and other factors can be used to classify investment options.
EPS growth and the P/E ratio are used by some analysts to set criteria. Other analysts focus on asset class rather than performance.
Investors are advised to diversify their portfolios to reduce risk.
Most Popular Asset Classes?
Stocks, bonds, and money market instruments have traditionally been the three main asset classes.
Most investment professionals include real estate, commodities, futures, financial derivatives, and cryptocurrencies in their asset class mix.
Which Asset Class Yielded the Most Historically?
Stocks have the highest long-term returns. Assuming all dividends were reinvested and adjusted for inflation, the S&P 500 has grown 6.6% annually since the late 1920s.
Without inflation, $100 invested in the S&P 500 on Jan. 1, 1928, would have been worth $42,500 (in 1928 dollars) by Dec. 31, 2022. $727,560 in 2022 dollars. Investing $100 in five-year Treasuries would have yielded just over $7,000 today.
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Asset Classes—Why So Useful?
Financial advisors help investors diversify by asset class to maximize returns. Diversifying across asset classes ensures investment diversity.
Each asset class has different risk and return investment characteristics and performs differently in any market environment.
Conclusion
Asset classes are groups of investments with similar characteristics and regulations. Asset classes include stocks, bonds, commodities, and property.
Since asset classes have different risk and return characteristics, they can diversify portfolios and reduce risk.
If stocks fall, bond prices rise, and vice versa. Diversification requires a portfolio with non-correlated asset classes.
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