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 favored asset classes are stocks and cash.
In contrast to the risk, return, and liquidity profiles of cash, stocks have their own 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 often divide their portfolios into different asset classes by risk/reward capacity.
Each asset class has its unique risk profile and potential for growth.
While some investors like a balanced portfolio with exposure to many different asset classes, others specialize in just one or two areas 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 tailor your portfolio further to meet your needs. Keep in mind that asset classes can overlap in some cases.
- Equity: Equity investments are those whose value is determined by a company’s performance. You can purchase stocks in the stock market or get them from an initial public offering (IPO) or acquisition of another company. Some equity investments may have little or no risk depending on the company, 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 can be risky and volatile. Many types of bonds are available depending on their risk level, the amount of interest they pay, and the expiration length. These factors affect their price and risk ratio and should be carefully considered before purchasing a bond. Government, corporate, municipal, and Treasury Inflation-Protected Securities (TIPS) are examples of fixed-income investments.
- Real Assets: Real assets are tangible assets with a long history of being used as a store of value, including gold, silver, diamonds, oil, and gas. These investments are generally considered a haven during 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 often used for fuel or food. 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.
- Crypto assets: There is a growing trend among institutional investors to accept and invest in Bitcoin and other crypto assets, which are becoming a new asset class. However, these are considered the most risky and volatile. Regardless, there is likely to be an increase in specialization, sophistication, and use cases, including DeFi and NFTs. Many investors (like Blackrock) want to include Bitcoin in their portfolios, but they may broaden their investment to include other digital assets in the future.
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, some 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.
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 rising interest rates generally hurt all stocks.
Cash can be unusually risky sometimes, 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 absolutes, which is why diversity is essential.
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.