If you’re new to investing, you might find yourself asking, “What is an asset class?” In short, there are multiple kinds of investments, and when a group of them share similar characteristics, they can be considered an asset class.
One particular class of assets is likely to have different levels of risk and return from another class, and they’re likely to perform differently from each other in the market. As such, financial advisors often try to include investments from multiple types of asset classes in a portfolio. Although all investing comes with some risk, diversification in your portfolio’s asset classes distributes your money in a way that might reduce your vulnerability and mitigate risk.
What Are the Different Asset Classes?
There are a number of types of asset classes you might consider as you build your portfolio. Beyond these larger asset classes, there are subgroups within them that have similar characteristics. Subgroups could include stocks from a certain industry or company size, or a particular kind of real estate, like residential, commercial, or retail.
Further, it’s sometimes challenging to precisely pigeonhole an asset. For example, exchange-traded funds (ETFs) can defy clear classification, as they can contain investments from multiple asset classes. Plus, some financial analysts consider domestic investments to be in a different asset class from foreign ones.
Fortunately, you don’t have to be able to clearly classify each asset into a hard and fast class to invest in them as part of your diverse portfolio. Here’s a look at the different types of asset classes you might encounter in your investing journey:
• Stocks (equities): Each share of stock is a single ownership share in a publicly-traded company, meaning a company that trades on a stock exchange. You can receive dividends from stocks if a company pays out part of its profits, or you might get capital gains when you sell if the price of the stock has risen.
• Bonds (fixed income): These are loans you make to a company or government for a predetermined amount of time at a certain amount of interest. These include Treasury bonds, corporate bonds, municipal bonds, and mortgage- and asset-based bonds.
• Money market accounts or cash equivalents: When you put money into a money market account, savings account, or certificate of deposit (CD), you’re lending money to the financial institution. In exchange, you get paid interest on the money.
• Real estate: This can involve buying real estate for the purposes of renting the property to generate income or to earn profits as the value of the property appreciates. Some experts would move real estate up to the traditional asset list.
• Commodities: Some investors put money into metals, energy products, livestock, agricultural products, and so forth. A common way to do this is through what’s called a futures contract. This is an agreement to buy or sell a certain commodity at a specific quantity at a predetermined price at a later time.
• Cryptocurrencies: This involves investing in digital currency that is largely unregulated. Typically, cryptocurrencies rely on a direct financial exchange between users, with no involvement from a bank or other third party. Crypto assets are highly volatile, so investors should exercise caution before buying.
• Real estate investment trusts (REITs): REITs invest primarily in real estate or real estate loans. They are traded like stocks.
Which Asset Classes Are Right for You?
Basically, it depends. When thinking about which asset classes you should invest your money in, it might help to consider your unique goals.
Goals-based investing is an investment approach where, rather than looking at market benchmarks, you focus on what you need your money for and when you’ll need it. This approach allows you to plan for different goals — think retirement, a house down payment, your kids’ college tuition — using different investment strategies. You may also hear it called goals-driven investing. To invest according to this philosophy, it’s key to know what your goals are, both short-term and long-term.
There are also traditional investment strategies to try. These measure risk tolerance and look at portfolio returns. Using that information, you’d decide how you wanted to invest and what your portfolio should look like.
Remember that the decision you make on which asset classes you want in your portfolio isn’t a final one — things change, and so can your portfolio. Additionally, your portfolio can include investments in multiple asset classes, each with their own levels of risk and return.
Over time, assets have returns and losses, which means the value of each asset changes. This is why an important part of investing is portfolio rebalancing, which simply means adjusting your investments — i.e., making changes so your asset allocation continues to fit your goals and risk tolerance. Rebalancing also gives you an opportunity to review what’s in your portfolio and make sure that’s still where you want to invest.
Where Should You Start?
How you should invest typically depends on multiple factors, including your personal preferences, your risk tolerance, and how actively you want to be involved. In other words, it’s important to get insight into what type of investor you might be.
From there, you can identify which types of asset classes might make sense for your portfolio. Just remember that you’ll want to invest in a mix of different types of assets to ensure portfolio diversification.
As you can see, there’s a wide variety of different types of asset classes. There are more traditional asset classes, like stocks and bonds, and then there are newer asset classes, including things like commodities and cryptocurrencies. You might also run into alternative asset classes when building your portfolio, such as REITS. Just remember that which types of asset classes are right for your portfolio depends on your investing goals and personal preferences.
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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.