When dealing with investments, it is essential to understand the different categories of assets and investments that fall under each category. An asset class is a group of investments that share some similarities, including how they behave in the market, the buying process, and how they are regulated by the government. Historically, there have been three main asset classes, but today financial professionals generally agree that there are four main asset classes:
Stocks
Stocks represent ownership. When you buy shares in a company, you are purchasing a stake in that company. For example, if Company ABC has 100,000 shares outstanding, and you purchase 1,000 shares, you will own 1% of Company ABC. As a partial owner, you will have rights to a portion of the company’s profits, which are typically paid to investors in the form of dividends. The amount of dividends varies by company, and some companies may choose to use their profits to reinvest for growth.
Bonds and Debt
When you buy a bond from an organization, you are lending them money, which is why it represents debt. In return, the organization promises to pay interest on the loan in the form of periodic payments. This interest is paid to bondholders throughout the bond’s term, and the principal is returned at the end of the term (known as the “maturity date”). For example, if you purchase a $1,000 bond for five years with an annual interest rate of 2%, you would receive semi-annual payments of $10.
Money Market and Cash
Cash is any amount of money in the form of currency, whether domestic or foreign. This can include bills, coins, and funds held in your bank accounts. Cash equivalents, such as money market holdings, are investments that are quickly converted to cash – typically within 90 days or less. Unlike stocks and other assets, cash equivalents must have a defined market price that does not fluctuate.
Real Estate and Tangible Assets
Tangible assets – those you can see and touch – are part of their own asset class. Real estate is the most common type of tangible asset among individuals, but commodities like gold and livestock also fall under this category. Generally, these assets can withstand inflationary periods.
Utilizing All Classes
The goal of having all four asset classes in your portfolio is not only to prevent investment losses but also to take advantage of the different strengths of each class. The entire theory of asset allocation relies on diversifying your portfolio by asset class; you never want to find yourself in a situation where your portfolio’s performance depends on just one asset class. Stocks give you a chance to achieve higher returns, but they also come with more risk; bonds do not offer large gains, but they are one of the safer investment options. It is your responsibility to know which asset combination makes the most sense for you.
Note: The younger you are, the more aggressive your portfolio should be. As you approach retirement, your portfolio should become more conservative, as you have less time to recover in the event of a market crash.
Conclusion
A portfolio containing only one or two asset classes is not diversified and may not be equipped to take advantage of all the market fluctuations it may face. However, diversification – or at least a degree of diversification – is also a personal decision that depends somewhat on your goals and risk tolerance.
Frequently Asked Questions (FAQs)
Which of the common asset classes is generally considered the least liquid?
Real estate is considered the least liquid among the common asset classes. While stocks, bonds, and money market funds can be traded throughout the day, transactions in real estate can take weeks to complete.
Which
What asset classes perform well during periods of inflation?
Commodities tend to perform well during inflationary periods. The inflationary environment increases the costs of businesses and consumer expenses in purchasing essential goods such as food, fuel, and construction materials. Traders can invest directly in commodities through exchange-traded funds, mutual funds, and futures contracts.
Source: https://www.thebalancemoney.com/use-all-four-asset-classes-to-build-your-portfolio-3141071
Leave a Reply