What are asset classes and what do they mean for an investor?

If you are beginning to invest you have probably heard the term “asset class” or “asset allocation”, and you might be wondering exactly what an asset class is.

Asset classes are groups of investments that have similar characteristics and must follow the same regulations.

There are many different types of investments to choose from, and they do not all have the same characteristics, risks and returns. Equities (stocks), for example, are different from bonds, carry different risks and offer different returns. It is important to understand different asset classes so you can diversify your investments to maximise returns and make choices taking into account your risk profile.

Traditionally there were three main asset classes:

Stocks – A security that represents an ownership share in a company. When you own stocks you own a fraction of a company. You are then entitled to an equivalent proportion of the company’s assets and profits.

Bonds – A loan made by an investor to a borrower (usually a company or government) in exchange for a fixed interest. Some bonds might also offer variable or floating interest rates.

Cash equivalents – Low-risk and low-return securities that are meant for short-term investing. They include treasury bills, bank Certificate of Deposits (CD’s), bankers’ acceptances and others.

Currently, alternative investments are also considered asset classes, such as:

Real estate – Property, including land and/or buildings. Investments in real estate can offer returns through cash flow (rental income) and/or increase in value.

Commodities – Basic goods such as grains, oil and gas. These goods are interchangeable with other goods of the same type, so prices are not affected by who produced them.

Cryptocurrencies – Digital currencies that use cryptography such as Bitcoin and Ethereum. They are difficult to counterfeit and are usually not issued by any central bank.

Futures – An agreement to buy or sell assets (such as a commodity or financial instrument) at a predetermined price at a specific time in the future. Futures allow investors to speculate on the future prices of those assets.

Other types of alternative investments include derivatives, valuable inventory (such as artwork) and venture capital.

Some asset classes are fixed income investments and others variable income.  Fixed income investments pay investors a fixed interest or dividend until its maturity date, when the principal amount is paid back to the investors. Some examples of fixed income are bonds and CD’s. Variable income investments do not offer a fixed return. Returns vary according to the changes in prices and other factors, and so the investor does not know the returns ahead of time. These types of investment are usually riskier but can also provide better returns.

It is recommended to include different asset classes in your investment portfolio. Each asset class performs differently, carries different risks and offer different returns. Diversifying your portfolio is recommended to reduce risks while maximising your profits.

Personally, the majority of my portfolio is allocated to variable-income (individual stocks and local and international index funds), with a small portion allocated to fixed-income (peer to peer lending). This is certainly not a recommendation and definitely not a mix that will work for everyone. When defining your allocation you must consider factors like your age, goals, portfolio size and risk tolerance. Read more about defining your asset allocation here.

What asset classes do you prefer to invest or are you going to invest in? Would love to hear your thoughts in the comments below.


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