An asset class is a category of investments, or assets, that are similar to one another and behave in certain ways. Stocks, bonds, commodities, real estate — these are examples of asset classes that tend to behave similarly in certain markets, and are generally subject to the same set of regulations.
Because various asset classes reflect different markets, they typically have different risk profiles, and can provide investors with a range of options for their portfolios. For example, the equity market consists of stocks, which are generally higher risk than bonds, which are part of the fixed-income market.
When constructing a portfolio, investors need to be aware of how different asset classes can create diversification, which can help manage risk.
Key Points
• An asset class is a category of investments that share similar characteristics, are traded via the same market, and fall under the same regulations.
• Stocks, bonds, real estate, commodities, currencies, cash and cash equivalents, are some of the larger asset classes.
• Different asset classes are part of different markets. As such, they typically have different risk profiles.
• In order to construct a well-balanced portfolio, investors need to be aware of how different asset classes create diversification to help manage risk.
What Are the Different Asset Classes?
There are many types of asset classes you might consider as you build your portfolio. Some of the larger asset classes include stocks or equities, bonds (also called fixed income), commodities, real estate, cash and cash equivalents, currencies, and more.
• Stocks (equities): Each share of stock is a single ownership share in a publicly traded company, meaning a company that trades on a stock exchange. Equities tend to be higher risk investments, with the potential for rewards. You can receive dividends from stocks if a company pays out part of its profits, or you might see gains when you sell, if the price of the stock has risen.
• Bonds (fixed income): Bonds are debt instruments, or loans, that you make to a company or government, for a certain amount of time, at a guaranteed rate of interest.
Bonds can include Treasury bonds and T-bills, corporate bonds, municipal bonds, mortgage- and asset-based bonds, and more.
• Money market accounts (MMAs) or cash equivalents: When you put money into a money market account, savings account, or certificate of deposit (CD), you’re lending money to the financial institution. In exchange, you get paid a fixed rate of interest on the money. MMAs and other cash equivalents may not offer high yields, but they do come with lower risk.
• Real estate: This can involve buying real estate (e.g., residential, commercial, medical) for the purposes of renting the property to generate income, or to earn profits as the value of the property appreciates. Real estate investments can also include real estate investment trusts, or REITs, which provide access to income-producing properties of various types, without the need to own actual property.
• Commodities: Some investors put money into precious metals, energy products, livestock, agricultural products, and other raw materials known as commodities. Commodities are traded through futures contracts. This is an agreement to buy or sell a certain quantity of a commodity at a predetermined price at a later time.
• Currencies: Foreign currency trading is typically conducted via “forex trading” or the foreign exchange market.” Forex generally refers to fiat currencies, or those backed by a specific government. For example, an investor could trade their U.S. dollars (USD) for euro, or Japanese yen for Canadian dollars.
• Alternative asset classes: Alternative investments, or alts, refer to higher risk, less liquid investments like collectibles, real estate, derivatives, private equity, and more. Alts are generally not correlated with traditional stock and bond markets, so they can help diversify a portfolio and mitigate risk. But alts are also less transparent and less well regulated than conventional asset classes.
Recommended: What Are Alternative Investments? Definition and Examples
How Asset Classes Can Be Divided
Beyond these larger asset classes, there are subgroups within them that have similar characteristics. Subgroups could include stocks from a certain industry (e.g., pharmaceuticals) or company size (e.g., large-cap stocks), or a particular kind of real estate, like residential, commercial, or retail.
Further, it’s sometimes challenging to pigeonhole an asset. For example, exchange-traded funds (ETFs) may contain investments from multiple asset classes. Also, some financial analysts consider domestic investments to be in a different asset class from foreign ones.
Fortunately, you don’t have to be able to classify each asset in order to invest in them as part of a diversified portfolio.
What Is Diversification?
Portfolio diversification is when you distribute your investments across asset classes, industries, sectors, and so on, in order to better manage risk.
It’s tempting to invest in certain industries or sectors that are familiar. While this may feel like you’re protecting your portfolio from risk, in fact, limiting your portfolio like this could expose you to the risk of greater losses.
Recommended: Why Portfolio Diversification Matters
Which Asset Classes Are Right for You?
When thinking about which asset classes you should invest in, also known as your asset allocation, it might help to consider your goals.
Your Goals and Your Portfolio
Goals-based investing is an investment approach where, rather than looking at market benchmarks, you focus on what you need your money for and when you’ll need it. This approach to setting up a portfolio helps you to select investments that align with different goals: e.g., retirement, a down payment, college tuition — using different investment strategies.
For example, a short-term goal like funding an emergency account might require lower-risk asset classes like cash and cash equivalents. A longer-term goal like retirement might do better with an allocation to equities, which do come with a higher risk exposure, but can potentially provide bigger gains over time.
Asset Allocation: A Personal Choice
Remember that the decision you make on which asset classes you want in your portfolio isn’t a final one — things change, and so can your portfolio. Additionally, your portfolio can include investments in multiple asset classes, each with their own levels of risk and return.
Over time, assets have returns and losses, which means the value of each asset changes. This is why an important part of investing is portfolio rebalancing, which simply means adjusting your investments — i.e., making changes so your asset allocation continues to fit your goals and risk tolerance.
Rebalancing also gives you an opportunity to review what’s in your portfolio and make sure that’s still where you want to invest.
Where Should You Start?
How you should invest typically depends on multiple factors, including your personal preferences, your risk tolerance, and how actively you want to be involved. In other words, it’s important to get insight into what type of investor you might be.
From there, you can identify which types of asset classes might make sense for your portfolio. Just remember that you’ll want to invest in a mix of different types of assets to ensure diversification.
The Takeaway
There is a wide variety of asset classes that investors can choose from. There are more traditional asset classes, like stocks and bonds, and then there are newer asset classes, including alternative investments. Just remember that which types of asset classes are right for your portfolio depends on your investing goals and personal preferences.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
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