Types of Asset Classes

As an investor, the one thing you certainly have is options. There’s an assortment of investments to choose from, all belonging to varying asset classes, each with unique rewards, risks, and implications for your portfolio. But how do you know which one is right for you?

This article will define asset classes, including what makes them up and the several different types. We’ll also go over the practice of diversifying across various classes and how a financial advisor can help you figure out what that looks like for you.

What Makes Up an Asset Class?

An asset class refers to a specific category of investment vehicles that share comparable features. In addition, the assets within each grouping may share similar risks and returns, as well as adhere to the same sets of regulations. Think of the assets within a class like siblings that live in the same household. They often share similarities in appearance, trajectory, and the rules they must follow.

Grouping assets is helpful when diversifying, as it allows an investor to zoom out and be sure to add different classes to their portfolio. For instance, to create a balanced portfolio of multiple types of assets, one may add a more lucrative and, by extension, risky investment such as stocks (equities). However, they may also include a less risky one, such as bonds (fixed income).

Cash and Cash Equivalents

Cash and cash equivalents comprise any liquid assets you own. In other words, these would be funds you have ready to use at a moment’s notice, such as for an emergency or a large purchase. Having both in your portfolio can be useful, especially if you need immediate cash without having to sell valuable assets such as stocks or real estate. The biggest downside to watch out for, though, is that liquid cash and equivalents can fail to keep up with inflation. And, while cash equivalent investments are generally low risk, there’s always a chance of losing money if you decide to liquidate them.

In terms of cash, this is typically money sitting in a savings or checking account, as well as miscellaneous cash you’ve tucked away in a physical location such as a wallet or safe. Things get slightly more technical with cash equivalents, however. These could include a variety of short-term assets, all with the common factor that you can easily turn them into cash. Below is a list of common ones:

• Treasury bills
• Guaranteed investment certificates (GICs)
• Certificates of deposit (CDs)
• Money market funds
• Short-term government bonds

Fixed-Income

Another primary asset class is fixed income-securities. When you buy one, you lend money to an entity known as an issuer. Then, you’ll receive consistent interest payments on your loan throughout a specified maturity period. Upon the end of the term, you’ll receive the initial amount you put in. Fixed-income assets are often bonds (e.g., corporate, municipal, Treasury, international, etc.), but they can also include CDs and annuities.

Assets with stipulated income structures generally carry a smaller level of risk. This is because the issuer contractually agrees to pay you back. But with the lower assumption of risk, you also don’t stand to have as high returns as you would with, say, stocks or mutual funds.

Equities

More commonly known as stocks, equities are shares you own in a company. They also include any ownership you have in mutual funds and exchange-traded funds (ETFs). You can trade these on stock exchanges through both brokerage and retirement accounts. Returns can come in the form of dividends, which are a piece of a company’s profit, and the appreciation of your shares.

Equities can generate substantial returns, especially if you hold them for a long time. This is because it allows a company ample time to grow in value. However, stocks can also carry enormous risks. Since there’s no guarantee of the companies you’ve invested being profitable or positive market conditions, there’s always a chance of losing money.

Commodities

Commodities are real-life goods with tangible value. This may commonly include items like:

• Crude oil
• Natural gas
• Precious metals (e.g., gold, silver, and platinum)
• Agricultural products (e.g., sugar, cotton, corn, wheat, etc.)

Investing in commodities can take place in many forms. For example, you can buy into a mutual fund or an ETF that has one, as well as a futures contract or derivative. This allows you to buy shares of the goods without having to physically own them. You can also buy the actual objects and hold them as their value appreciates.

The primary benefit of commodities is that they perform differently than other popular assets, such as stocks and bonds. Rather than relying on a company to perform well, valuable goods receive their value from demand. Higher demand drives up their value and, by extension, the value of your shares. Therefore, when inflation occurs and products become more expensive, the commodities you own become more valuable.

Commodities aren’t without their risks, though. The most prominent one is the reduction of their value due to market fluctuations, often due to natural disasters and economic events.

Real Estate

Real estate involves the ownership of both commercial and residential property. Buying a home can be an accessible way to invest in a high-value asset with the ability to appreciate significantly over time. Investors can also take an active approach and acquire more than one property to rent them out to create a stream of cash flow.

As with commodities, you don’t have to buy physical property to get into the real estate game. There are various passive options to consider. Real estate investment trusts (REITs), for example, allow you to own shares of an income-generating commercial property. Others include crowdfunded projects, syndications, or mutual funds.

Real estate can generate large returns over time. But this can take a while and is often only true under the right market conditions. The largest risk with this class is that, as housing or commercial markets experience problems, you could lose value in your property. In the 2008 housing crisis, for instance, the median price for a home in the U.S. dropped from $217,900 in 2007 to $197,100, according to CNN. While this is a more extreme example, it shows that property values closely follow larger, erratic market situations.

Alternatives

There are several alternative classes of assets you can add to your portfolio. These are often more difficult to sell than stocks, bonds, or cash and equivalents. In some cases, they may be tougher to value due to having subjective qualities.

Adding alternatives to your collection of investments can be a good idea for diversification. Since they’re different than the traditional asset classes, they could hold their value if your other assets go down. However, as mentioned, their glaring drawback is their illiquidity and lack of regulation, especially for assets like cryptocurrency that have just recently entered the spotlight.

Here are examples of alternative investments:

• Collectibles (e.g., art, cars, stamps, etc.)
• Cryptocurrency
• Hedge funds
• Venture capital

Diversifying Asset Classes

Often recommended by financial advisors, diversification is an important strategy for putting together a well-performing portfolio. One way to do this is by allocating your assets across multiple classes. This lowers the chance of losses due to market volatility and may provide more options for liquidity.

To vary your assets across classes, consider investing in ones that perform in opposite ways to one another. This helps ensure that, even if one goes down, the others are still propping your holdings up. Government bonds, for instance, are lower risk and more liquid than having a stake in an index fund. However, the latter could provide dividends and grow much more in value over a longer period.

Achieving diversification takes research and plenty of care. In most cases, it makes sense to discuss with a financial advisor how to put together investments that work for you and your needs. After answering a few questions, this free matching tool can help you find a vetted professional.

Frequently Asked Questions

What is the riskiest asset class?

Equities are the riskiest class. This is because positive returns hinge on the companies you’ve invested in performing as expected or better. However, businesses could suffer problems with management or could run the risk of losing out to competitors. The markets also often tend to have a mind of their own. As they go down, your shares could drop in value.

What is the safest asset class?

Generally, the safest is cash and its equivalents. Unlike equities or real estate, you can often control how they perform. Since they’re either liquid or easy to convert, you can use them whenever you need them. Even so, it’s probably best to seek the expertise of a financial advisor to find out the most suitable asset classes to choose.

What asset class does well during inflation?

Commodities tend to do well during inflation. Since they operate much differently than other typical assets (i.e., equities or stocks), they gain value when inflationary factors, such as demand, are in play. A more recent example of this concerns gas prices. While oil remains in high demand due to inflation, driving up gas prices for consumers, investors with oil in their portfolios see growth.