In a nutshell
Assets come in many forms, but are classified into asset classes. For example, equities form one asset class because all equities share similar features. Different asset classes are governed by their own rules, react differently to market conditions and have different expected returns.
- Common asset classes include equities, fixed-income, cash equivalent and alternative investments.
- Investing across different asset classes can help you diversify and balance your portfolio. This reduces your risk and potentially increases your returns.
What is an asset class?
An asset class is a group of similar types of investments. Investments in a given asset class may be subject to similar rules and regulations by governing authorities.
While investments in a particular asset class may perform similarly under the same market conditions, those in a different asset class often perform differently. For example, the performance of stocks may not be correlated with the performance of bonds or gold.
Understanding asset classes
The four most common type of asset classes are:
- Equities.
- Fixed-income.
- Cash equivalents.
- Alternative investments.
This means, for example, that all equities fall into one asset class. However, there is a great deal of variation within each class. While it’s important to invest in different asset classes, it’s also crucial to pick the right investments within each class.
Types of asset classes
Equities
The term “equity” refers to ownership, and equities as an asset class typically refers to company stock. These stocks represent a share, or portion, of ownership in a particular company. Rather than retaining 100% ownership, public companies typically sell shares on a market exchange, such as the New York Stock Exchange or Nasdaq, to help generate cash for business objectives. In exchange, the owners of these shares can potentially profit from the company’s success.
While your shares of stock may generate high returns if a company succeeds, there’s no guarantee of success. Stocks may decline in value, depending on company performance and the overall market. And it’s possible you could lose your investment entirely if a company goes bankrupt.
Individual stocks and equity funds, or baskets of similar stocks, are available through traditional brokerages or financial services companies like Fidelity and Public. You can generally make money from equities by selling your shares for a higher price than you paid or by investing in dividend stocks, which provide fixed payouts over time.
Fixed-income
Fixed-income investments are another standard asset class. These investments, which include corporate and government bonds, are generally considered less volatile and lower-risk than stocks. Bonds are debt instruments, or loans, made to an issuer for a set term.
You can purchase bonds or bond funds through a brokerage or directly from certain government sites. In exchange for your bond purchase, the issuer — typically, a corporation, state or local government — will pay you interest at regular intervals for the bond’s term. Once the bond matures, your initial investment will be returned to you.
Bonds issued by federal, state or local governments tend to be low-risk. Corporate bonds may carry slightly more risk, so understanding credit ratings and company performance is essential before you invest.
Cash equivalents
Similar to fixed-income investments, cash equivalent investments are also a secure and low-risk asset class. As their name suggests, these assets either are or behave similarly to cash. Examples of cash equivalent investments include:
Some cash equivalent investments also belong to the fixed-income asset class. For example, U.S. Treasuries, or bonds issued by the federal government, are a type of cash equivalent investment. These bonds are guaranteed by the U.S. government, so there’s virtually no risk involved when you purchase them.
Alternative investments
Alternative investments is a broad asset class that includes many different types of investment. Commodities, cryptocurrency, real estate, precious metals, futures and collectibles are often considered alternative investments. However, depending on who you ask, the category could also include private equity, hedge funds or crowdfund investing.
Assets in this class are less heavily regulated and carry higher risk than the other three “traditional” asset classes. On the other hand, they can also offer faster, greater returns on investment.
Here are some examples of platforms that support alternative investments:
Importance of diversification
If you’ve invested through a recession, you probably already understand the importance and impact of diversification. Maintaining a portfolio of investments in different asset classes can lower the risk of your investment portfolio, because it’s unlikely that all asset classes will be equally affected by market events. Diversification can therefore protect you from events outside of your control that impact your finances.
For instance, if you invest a portion of your money in fixed-income assets, it could protect you if the stock market declines unexpectedly and your equity investments decrease in value. Certain investments, like bonds, have traditionally had a negative correlation with stocks, meaning the two can balance each other out when interest rates are high or the market is declining. It’s worth noting that stocks and bonds both fell in tandem during 2022.
Related: How to rebalance your portfolio
Diversification within asset classes
Likewise, diversification within asset classes is also crucial. Using all your funds to purchase shares of stock in one company, for example, could expose you to significant risk if that company goes bankrupt, costing you your entire investment. As the old saying goes: Avoid putting all of your eggs into one basket.
The AP Buyline roundup
Asset classes are categories of similar types of investments, including equities, fixed-income, cash equivalent and alternative investments. Building a diversified portfolio by investing across multiple asset classes can help protect you from stock market declines, company bankruptcies and other negative market events.
If you’re thinking about investing, consult with an investment professional to determine the best possible strategy based on your age and risk tolerance.
Frequently asked questions (FAQs)
What are the most popular asset classes?
Common asset classes include equities, fixed-income, cash equivalent and alternative investments. Each asset class includes investments that perform differently depending on market conditions and other factors.
Which asset class has the best historical returns?
Equities have the best historical returns over the long term, though there’s generally more risk involved with equity investments, and past performance isn’t a guarantee of future success.
Why are asset classes useful?
Asset classes provide a simple way of describing the different types of investments in your portfolio. Investing a portion of your funds in different asset classes helps you diversify your investment portfolio and hedge against risks like economic declines or company bankruptcies.
