What Is an Asset Class?
An asset class is a group of investments that have similar characteristics, are subject to the same laws and regulations, and generally respond similarly to market fluctuations. Historically, the main asset classes have been equities (stocks), fixed-income assets such as bonds, cash or cash equivalents, and tangible or real assets.
Definition and Examples of Asset Classes
An asset class is a group of investments that have similar traits in terms of risk and growth potential, and also tend to respond similarly to market fluctuations. They are a means of grouping similar securities together, partly for investment strategy purposes. Diversification of one’s investment portfolio—an important tenet of investing—is easier to understand and carry out because asset classes exist.
The most common asset classes in investing portfolios include:
- Cash and cash equivalents (e.g., money market funds)
- Equities, like U.S. and foreign stock
- Fixed-income securities
- Real, tangible assets
5 types of asset classes
Here are five common types of asset classes:
1. Equity asset class
Equities, also known as stocks, are shares of ownership in publicly held companies. Equities are sold on the stock market and are one of the most popular forms of investing. Investors may earn a return through dividends, which are typically quarterly payments based on a company’s revenue. Dividends may be in the form of cash or additional stock.
An investor can also earn money from their equities by selling them for a higher price, resulting in a profit.
2. Fixed-income security asset class
Fixed-income securities, also called bonds, are assets that involve lending money to a company or government for a set rate of interest. A fixed-income security can offer investors the opportunity to earn money through receiving interest payments or by receiving a larger payment when a bond reaches maturity and a higher value. Value, however, fluctuates by current interest rates and inflation. Examples include government bonds, savings bonds and certificates of deposit. Bonds, for instance, might be offered to raise funds for a municipal infrastructure or a new water treatment system. They typically offer stable returns, have a lower risk than equities and have lower returns.
3. Cash asset class
Cash assets, also called currency or medium of exchange, are made up of cash, short-term deposits or cash equivalents. A key characteristic of cash assets is their liquidity, which means they can be used as cash or converted into cash quickly. This can be especially valuable to investors who frequently reassess their investments and reallocate funds to different investments or financial purchases.
Here are a few examples of cash class assets:
Short-term government bond: A short-term government bond is a bond that matures more quickly than typical government or savings bonds.
Treasury bill: A treasury bill is a short-term debt that matures within one year or less.
Commercial paper: A commercial paper is a debt that large organizations use for short-term financial needs. It matures in less than a year.
4. Marketable commodity asset class
Marketable commodities are assets that retain their value over time. Most marketable commodities like artwork or collectibles are directly purchased. Investors can also invest in commodities like precious metals—gold and silver—through the stock market.
Other examples of marketable commodities include:
Many investors purchase and retain marketable commodities to maintain a high value in their assets. They also may sell their commodities for a higher price, resulting in a profit.
5. Real estate asset class
Real estate assets refer to property purchases and investments. This may include buildings, property lots, rental property or commercial real estate investments. The investments can offer high returns and profitability in situations like flipping a house or renting to tenants. There are also opportunities to invest in real estate without purchasing a property such as investing in a real estate investment trust, a real estate exchanged trade fund (ETF) or a mutual fund.
Asset Class and Investing Strategy
Investors looking for alpha employ investment strategies focused on achieving alpha returns. Investment strategies can be tied to growth, value, income, or a variety of other factors that help to identify and categorize investment options according to a specific set of criteria. Some analysts link criteria to performance and/or valuation metrics such as earnings-per-share growth (EPS) or the price-to-earnings (P/E) ratio. Other analysts are less concerned with performance and more concerned with the asset type or class. An investment in a particular asset class is an investment in an asset that exhibits a certain set of characteristics. As a result, investments in the same asset class tend to have similar cash flows.
Asset Class Types
Equities (stocks), bonds (fixed-income securities), cash or marketable securities, and commodities are the most liquid asset classes and, therefore, the most quoted asset classes.
There are also alternative asset classes, such as real estate, and valuable inventory, such as artwork, stamps, and other tradable collectibles. Some analysts also refer to an investment in hedge funds, venture capital, crowdsourcing, or cryptocurrencies as examples of alternative investments. That said, an asset’s illiquidity does not speak to its return potential; It only means it may take more time to find a buyer to convert the asset to cash.
What Are the Most Popular Asset Classes?
Historically, the three main asset classes have been equities (stocks), fixed income (bonds), and cash equivalent or money market instruments. Currently, most investment professionals include real estate, commodities, futures, other financial derivatives, and even cryptocurrencies in the asset class mix.
Which Asset Class Has the Best Historical Returns?
The stock market has proven to produce the highest returns over extended periods of time. Since the late 1920s, the CAGR (compounded annual growth rate) for the S&P 500 is about 7.63%, assuming that all dividends were reinvested and adjusted for inflation.1 In other words, one hundred dollars invested in the S&P 500 on Jan. 1, 1920, would have been worth about $167,500 (in 1928 dollars) by Dec. 31, 2020. Without adjusting for inflation the total would have grown to more than $2.2 million in 2020 dollars. By comparison, the same $100 invested in 10-year Treasuries would have been worth only a little more than $8,000 in today’s dollars.
Why Are Asset Classes Useful?
Financial advisors focus on asset class as a way to help investors diversify their portfolios to maximize returns. Investing in several different asset classes ensures a certain amount of diversity in investment selections. Each asset class is expected to reflect different risk and return investment characteristics and perform differently in any given market environment.
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