The most important thing to take away from asset classes is that it is best to have a diversified portfolio; which means you should hold some assets from each class.
A diversified portfolio helps ensure steady growth and protection from market volatility. The reason that diversification is such a useful strategy is that it is unlikely that all asset types will have equal losses at the same time.
What are asset classes exactly?
There are three main asset classes and one secondary class:
- Equities or stocks
- Bonds or fixed income
- Cash Equivalents or money market instruments
- And “Alternative Assets” or valuable property and collectibles
An asset class describes a group that consists of similar investments. They will be similar in multiple ways, this includes being governed by the same laws and regulations. It is important that there is very little overlap or correlation between the three (or four) classes for two reasons.
The first reason is that each class represents a different kind of asset; equities, bonds, and cash all behave differently in the market as they are three very different assets.
The second reason is that it is important to know the difference between each. This is because the best investment portfolio is made up of all three classes.
Let’s look at each type of asset in more detail.
Equities are referred to as “ordinary shares.” Shares are issued by a public limited company. The company’s shares are bought and traded on the stock market. Buying shares in a public company makes you an owner of those shares, and therefore a “shareholder.”
The way that equities earn money is through capital increases and receipt of dividends. The investor earns capital when the company’s value increases. Dividends are slightly different, as a dividend is when one receives a payment from the company based on revenues.
Bonds are essentially a steady stream of income, this is in part because they are similar to a loan. Here’s how they work. Bonds are basically a fundraising mechanism for projects organized by companies and governments. The benefit of a bond to the investor is that they typically have steady lower returns, and as such, less volatility and lower risk.
Government bonds are generally considered a safe investment. On the other hand, bonds in any project, public or private, also exposes the investor to risk, because there is never any certainty in the success of an asset.
Overall, bonds are valuable as long rather than short-term investments as they are sensitive to the variation in interest rates.
Cash is not a very lucrative investment because it does not earn much on its own. This class is used primarily for short-term savings plans, for instance, to save for deposits or downpayments. With this asset, you are earning basic interest, which is good because it is very low risk. But a low level of risk usually means it is a low yield asset.
Just because cash is not a high earning asset does not mean it is not a good one to have, however. Remember, the goal of a strong portfolio is to be diversified. Moreover, there are many other kinds of investments that will need initial cash capital.
One investment strategy for cash is to find a competitive interest rate.
Alternative Asset Class
Almost any valuable property can be considered an “alternative asset.” This is not an official asset class, but an important class no less. Items that go into this category are assets like real estate, valuable jewelry, artwork and collectibles, such as stamps and coins. Cryptocurrencies also fall under alternative assets, presently.
Alternative investments are excellent but may require a more niched knowledge set. For instance, real estate and jewelry are only good investments if they are likely to be valued higher in the future. Industry experts in these niches would have more knowledge about the value as well as future prospects.
Each asset class will experience high and low-performance rates; this is the nature of the market. The value of a multi-asset portfolio is that it will be more prepared to take the lows and poised to receive benefits of the highs. Nevertheless, even a diversified portfolio is not fully protected from the fluctuations of the market.
Asset Class Types
- There are three main asset classes: equities, bonds, and cash.
- These three assets classes are the most liquid assets.
- Alternative assets include real estate, artwork, valuable collectibles, and cryptocurrencies.
- An asset’s illiquidity is determined by how easy to find a buyer it will be. It is not based on its return potential.
An asset class is a collection of similar kinds of investments. There are three official categories, which means that they are subject to the same laws and regulations. There is a fourth unofficial category of valuable assets that do not fall into the main three classes.
The different classes are important to understand for the sake of a diversified portfolio. Diversification is the best way to hedge your investments and have to most longterm success with your investments.
Each category is subject to different yields based on interest rates and performance. Equities will have higher yields than bonds and cash. However, equities are much for volatile and subject to bearish markets, so it is a good idea to have some safer slow-growing investments. Because all four categories are going to behave in a different way based on different economic conditions, holding some of each class is the best way to the longevity of a healthy portfolio.
Finally, these three classes do not represent the many kinds of assets and commodities within each category. They are important to know some of the technicalities of how your investments are treated and how they behave in the market.