- An asset class is a group of financial instruments which hold similar characteristics and react similarly to one another within the marketplace and which are subject to the same rules and regulations
- Stocks, bonds, cash, real estate, cryptocurrency and other derivatives are all different types of asset classes with varying levels of liquidity
- Because different asset classes are linked to one another, they determine how how others react in the marketplace
- Investors should include a combination of assets to counterbalance the upward and downward swings happening in their portfolio
Types of Asset Classes
There are different types of assets. Equities (stocks), fixed income (bonds), and cash equivalents are the most common asset class types, since they are considered the most liquid. But nowadays, most investment professionals include real estate, commodities, futures, other financial derivatives, cryptocurrencies, and other tradeable collectibles in the asset class mix. If you want a more detailed explanation of each, keep reading!
- Equities (stocks): These refer to the shares you own within a company. They are made up of small-cap, mid-cap, and large-cap stocks, based on the company’s market capitalization.
- Fixed-income investments (bonds): Bonds are securities that distribute payments in the form of interest or dividends.
- Cash or cash equivalents: As the most liquid form of asset, they consist of money market instruments, short-term government bonds, marketable securities, and commercial paper.
- Real estate: Real estate falls outside more traditional categories such as stocks and bonds, since it is more tangible and less liquid.
- Forex, futures and other derivatives: This category includes futures contracts, spot and forward foreign exchange, and financial derivatives. Derivatives are financial instruments that are based on, or derived from, an underlying asset. For example, stock options are a derivative of stocks.
- Cryptocurrency: Crypto represents a new and emerging asset class and gives individual investors exposure to the demand for decentralized digital currency.
- Other tradeable collectibles: These are an asset class which don’t fall into the typical realm of investing, but are investments nonetheless. These are possessions you hold which increase in value over time.
Investment Asset Classes
When it comes to investing, you simply need a basic understanding of each asset class and how they react in the marketplace. That’s because different asset classes are related to one another. For example, when equities are performing well during a bull market, bonds, real estate, and commodities may not be performing well. However, during a bear market in stocks, other assets, such as real estate or bonds, may be showing investors above-average returns.
Therefore, it’s important to reduce investment portfolio risk by diversifying your investments across different asset classes. This process is referred to as asset allocation. The good news is that when investing in funds, for example, they will combine a mixture of bonds and equities.
How you proceed with asset allocation is down to each individual based on their investment goals and risk appetite. If you’re more comfortable with risk, then focussing on one type of asset with the highest potential returns might be more up your street. On the other hand, a risk-averse investor would go for a combination of assets to counterbalance the upward and downward swings happening in your portfolio.