Asset Class

Investments are classified into asset classes based on their common traits, behaviors, and laws.


What Is an Asset Class?

An asset class is a classification of investments based on common traits, behaviors and laws. For instance, two of the popular asset classes are stocks and cash. In contrast to the risk, return and liquidity profiles of cash, stocks have their own set of characteristics.
An asset class is a broad investment category with a common operating philosophy. For example, stocks, bonds and real estate are all asset classes. Investors will often divide their portfolios into different asset classes in accordance with their risk/reward capacity. Each asset class has its own unique risk profile and potential for growth. While some investors like to have a balanced portfolio with exposure to many different asset classes, others tend to specialize in just one or two areas that they understand better than others. 

Investment Asset Classes

The main categories of investment assets are stocks (equity), bonds, real estate and cash equivalents. You can further break these general categories into “sub-classes” or specific types of stocks, bonds, and so forth. This will allow you to further tailor your portfolio to meet your specific needs. Keep in mind that asset classes can overlap in some cases. For example, a REIT is a hybrid that can be considered both an equity and a real estate investment. 

When considering asset classes, it’s important to note that you must diversify your portfolio across multiple asset types and classes. While some asset classes tend to move up and down together, there are some that are not correlated. In other words, they may move in opposite directions at the same time. This diversification will help to minimize risk while increasing long-term returns.

Equity

Equity investments are those whose value is determined by the performance of a company. You can purchase stocks in the stock market, or get them from an initial public offering (IPO) or acquisition of another company. Depending on the company, some equity investments may have little or no risk, such as those in utilities or other regulated companies. Others, such as start-ups, may be extremely risky, but also offer the potential for high returns.

Fixed Income Bonds

Bonds are often considered a “safe” investment, but they can be very risky and volatile. There are many types of bonds available depending on their risk level, the amount of interest they pay, and the length of expiration. These factors affect their price and risk ratio and should be carefully considered before purchasing a bond. Government bonds, corporate bonds, municipal bonds and Treasury Inflation-Protected Securities (TIPS) are all examples of fixed-income investments.

Real Assets

Real assets are tangible assets that have a long history of being used as a store of value, including gold, silver, diamonds, oil and gas. These investments are generally considered a safe haven in times of economic uncertainty or high inflation. Investors may also purchase real estate as a long-term investment that can be rented out, such as a residential or commercial property.

Commodities

Commodities are raw materials that are often used as a source of fuel or food. Examples include corn, wheat, gold and oil. While some commodities may be used in manufacturing, most are traded on commodity exchanges. Gold is an exception, as it’s usually purchased as a store of value or a hedge against inflation. These commodities fluctuate in price, and generally follow the direction of the economy.

What Is the Riskiest and Safest Asset Class?

Cash and cash equivalents have historically been regarded as the safest assets, whereas shares have historically been among the riskiest. In either scenario, there may be exceptions. Some stocks are safer than others, though generally speaking, rising interest rates hurt all stocks. Cash can be unusually risky at times, such as when inflation is skyrocketing, and some stocks can be safer than others.

Cash is not considered a good investment, given the risks associated with inflation, whereas a broadly diversified portfolio of stocks has historically helped investors preserve their purchasing power.

We cannot speak in absolutes, which is precisely why diversity is important. Asset allocation, or diversifying your portfolio across different assets and asset classes, will improve portfolio performance while minimizing unpleasant surprises. Even though you can’t plan for everything, you can build a portfolio that lessens your exposure to unnecessary risk.