Asset classes demystified

To help balance out risk, a diversified portfolio should include a mix of asset classes.

Tags: Investing, Investments
Published: April 23, 2020

Asset classes are groupings of investments that have similar characteristics. Here are the most common asset classes, ranked generally from lower to higher risk:

 

Cash and cash equivalents

Many investors hold cash as a way of maintaining liquid assets or simply providing safety and comfort in volatile times. Cash equivalents include cash-like products such as Treasury bills and commercial paper.

Return: Cash and cash equivalents are considered low yield compared to some other investments.

Risk: There’s little risk when it comes to holding cash. When it comes to investing in cash equivalents such as commercial paper, a major risk is that the issuer will not be able to pay the debt at maturity. Before purchase, investors should consider the characteristics of the issuing company, the business climate of the company and the economy.

 

Fixed income (or bonds)

These investments make fixed payments (income) on a principal investment, with the principal returned at a specific future date. The most common fixed-income investments are bonds, but bonds aren’t the only type. For example, certificates of deposits are also considered fixed income.

Return: As the name implies, the yield on fixed income assets is fixed. You can generally determine your expected return when you first invest, but typically won’t make more than that.

Risk: The company or government issuing a bond could default and fail to repay the loan. Treasury bonds are considered a safer form of debt, since the U.S. government backs them.

Investments in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in fixed income securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities.

 

Real assets

Real assets are based on tangible things, such as buildings or a barrel of oil. The most common types of real assets are property and commodities. With property, investors might own office, apartment or industrial complexes expressly to sell or rent for a return.  Commodities refer to raw materials, such as oil, wheat or gold.

Return: Real assets can appreciate in value (though to realize your returns, you may need to sell the asset). Investment properties can also provide substantial income, and because rents often increase with cost of living, this can help investors combat inflation. Commodities earn return based on supply and demand (versus profitability).

Risk: Investments in real estate can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults).

Special risks associated with an investment in commodities include market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors.

 

Equities

Commonly known as stocks, equities are ownership shares of a company. There’s a wide variety of ways to own a portion of a company, from publicly traded shares to funds that own stocks — and even investments in privately held companies.

Return: When a company appreciates in value, your share of the company is worth more, too. A return can come in two ways – appreciation and dividend payments, both driven off the company’s earnings.  

Risk: It’s possible for you to lose money, including your principal investment. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.

 

 

Which asset classes you include in your portfolio, and how heavily you invest in each, should depend on your goals and your level of risk.

 

Ready to start investing but not sure how to do it? Read about your options in How to start investing.

 

Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment losses. All investment strategies have the potential for profit or loss.