All about asset classes
How different types of assets figure into your portfolio
An asset class is a group of investment vehicles that have a similar structure and are typically traded in comparable financial markets. Each asset class has its own profile of potential risks and returns over time.
Why is it important to know about asset classes? Because understanding asset classes is key to the battle-tested investment strategy of diversification. Different asset classes provide options for you to diversify your investments based on your goals, so you can put yourself in position to help maximize your returns given your risk tolerance.
Types of asset classes
Assets are generally divided into the following categories:
Stocks. This type of asset allows you to take partial ownership of a publicly traded company. By owning shares, you’re entitled to an equivalent portion of the company’s earnings as share prices rise. Some stocks also pay dividends—regularly distributed shares of the company’s profits. Stocks carry greater risks, especially in the short term, because investment returns are not guaranteed. However, over the long term, stocks have historically outperformed bonds.
Bonds and fixed-income investments. Bonds are debt securities. When you buy a bond, you lend a fixed amount of money to a government or company and receive interest payments in return—as well as, eventually, your principal. Bonds tend to be less risky than stocks and provide more predictable returns, but they typically yield lower returns over the long term.
Cash and cash alternatives. This asset class is characterized by physical currency or cash equivalents like money market funds, savings accounts and Treasury bills. Assets in this class tend to be easily accessed and liquidated, but they do not earn a substantial return and are vulnerable to inflation.
Real estate. This asset class covers investments in physical structures like apartments, commercial buildings and land plots. Real estate has the potential to bring higher returns than bonds, and its performance isn’t tied to the stock market, but the real estate market is unpredictable and subject to numerous economic forces.
While these are the most common asset categories, others do exist, including private equity and commodities.
With a private equity investment, you buy ownership in a private company that is not listed on a stock exchange. These investments may lead to higher returns than stocks in some cases, but they are only possible for wealthy investors who can afford to meet high minimum investment requirements.
Commodities, such as precious metals, can help hedge against inflation and their value typically rises and falls independently of that of stocks and bonds, but they can also experience extreme volatility.
How asset classes fit into your investment strategy
When building an investment strategy, it’s important to diversify—that is, invest in a mix of assets and asset classes—to build a healthy balance of investments that are appropriate for your financial goals and risk tolerance. This approach can help your portfolio withstand fluctuations in the market while potentially generating returns. Asset allocation and diversification do not ensure a profit or protect against loss.
You’ll want to diversify between and within asset categories. For many investors, mutual funds—which invest in a broad array of stocks and/or bonds—offer a convenient diversification tool. And many investors work with a financial professional to periodically rebalance their asset allocation as their priorities shift and market conditions evolve.