Asset ClassDefined along with Examples

Making investments isn’t something that you do without careful consideration.

Making investments out on a whim is almost synonymous with throwing away money.

It’s reckless and shouldn’t be practiced often.

Even better, you should never consciously practice it at all.

Seasoned investors thoroughly research any investments that they’re about to make.

They want to make money after all, not throw it away.

And most of these investors often don’t put all of their eggs in one basket.

Rather, they diversify their investment portfolio, investing in different kinds of instruments or securities.

Yes. There are more types of investments than the commonly known equities or stocks.

We can’t deny the potential of earning more with stocks (the right ones), yes, but there are other items that you can invest in.

There’s investing in fixed-income securities and debt instruments (e.g. bonds).

There’s also investing in money markets or foreign currencies.

And let’s not forget investing in real estate or high-value assets.

And we can also include investing in certain commodities such as gold and other precious metals.

Indeed, there are different classes of investments, and understanding them is essential if you want to make the most out of them.

These categories of investment are commonly referred to as asset classes.

Depending on which asset class an investment belongs to, certain regulations such as taxes or restrictions may or may not apply.

Aside from that, they offer different levels of risks and rewards.

In this article, we will be learning about the different asset classes.

We will learn about the characteristics of each asset class.

We will also look into some examples of instruments or securities that fall under each asset class.

What is an Asset Class?

An asset class refers to the grouping of investments with similar characteristics.

They are generally subject to the same rules and regulations.

Also, they have similar responses to market conditions and fluctuations.

To illustrate, think of the gadgets that you own and use.

I’m talking about mobile phones, laptops, desktop computers, gaming consoles, televisions, cameras, etc.

Now think of the similarities these gadgets have.

 For instance, laptops and desktop computers serve the same purpose (e.g. you can use them for work or entertainment).

You could play games on your mobile phone as well as your gaming console/s.

Then you could listen to music with your iPod or MP3 player.

Though these gadgets have similar characteristics, each is still unique.

For example, mobile phones have features that gaming consoles don’t have.

Assets classes work close to that. Each asset class is unique in that they have their own characteristics.

One asset class cannot replace another. Each asset class has its own level of risks, rewards, as well as liquidity profile.

This is why it’s important to properly identify which asset class an investment belongs to.

Just like they are different asset classes, they’re also different kinds of investors.

There’s the conservative investor who prefers low-risk investments.

There’s also the aggressive one who doesn’t mind high-risk investments as long have they have the potential to provide high rewards.

Then there’s the balanced investor whose investment portfolio is a mix of investments from each asset class.

Depending on how you diversify your investment portfolio, you may be able to minimize the risks while maximizing the rewards.

Do note though that no matter how well you diversify your investment portfolio, there are still inherent risks that come with investing.

Not even diversification can eliminate that risk.

The Asset Classes

While some sites mention that there are four asset classes, one can argue that there are five.

To address this confusion, let’s go with the five.

This is because the fifth asset class is different enough that it’s worth having a class of its own.

Here are the five asset classes:

• Equities (stocks)
• Fixed-income instruments and securities
• Money market and cash equivalents
• Real estate and marketable commodities
• Futures and other derivatives

Equities

The equities or stocks asset class includes investments that represent a share of ownership of a publicly-traded business.

Publicly-traded companies issue stocks to raise capital.

In exchange, the buyer of the stocks gains a percentage of the ownership of the company.

This entitles the buyer to a share of company profits, which usually comes in the form of dividends.

For example, if you own 1,000 of the 100,000 stocks that company ZX issued, you effectively own 1% of company ZX.

If company ZX declares and distributes dividends, you are entitled to 1% of the total dividends.

Aside from dividends, you can also profit from equities by selling them when the market price is higher compared to what you paid for them.

That said, you’ll be foregoing your investment in equities if you sell them.

Keep this in mind when you want to profit from the sale of stocks.

Some stocks are more stable than others. This is the case with blue-chip stocks, ones that well-known companies issue.

They are more stable due to the name attached to them.

However, they are often more expensive than the stocks that start-up companies issue.

So there’s the choice of going for expensive but fairly expensive stocks or cheaper but high-risk stocks.

Differences in industries can also influence the response of stocks toward market conditions.

There are defensive stocks, cyclical stocks, etc. These stock types behave differently from each other.

As such, they can influence your investing strategy for stocks.

Quite complicated, right? There’s also the volatility of the stock market which tends to intimidate new investors.

But to those who have the appetite for high-risk, high-reward investments, equities are a good choice for them.

Fixed-Income Instruments And Securities

Fixed-income instruments and securities include investments that act like loans to the issuer of such instruments.

This is why we also refer to them as “debt” or “bonds”.

An example of an investment that falls under this asset class is the certificate of deposit.

Banks and other financial institutions issue certificates of deposit to raise money.

In exchange, the holder of the certificate of deposit enjoys a higher rate of interest compared to regular deposits.

However, the holder cannot withdraw his/her deposit until the certificate of deposit reaches its maturity.

Investments that belong to this asset class tend to be more stable and safe.

Holders of these instruments enjoy a steady stream of income (usually in the form of interest).

Not only that, they assured that they will get the entirety of their investment at the maturity date of the instrument.

However, since the income is fixed, there is a risk of losing on these investments when the current market interest rate is higher than what the instrument provides.

There is also the risk of the issuer not paying. So it’s not like there is no risk when investing in fixed-income instruments.

Government-issued bonds are a different story though.

These are very secure investments, and can even be considered cash equivalents.

This is because it’s unlikely that the government will shut down – it will always be there to honor its debt or bonds.

However, they tend to offer lower returns than other instruments making them low-risk, low-reward investments.

Money Market And Cash Equivalents

This asset class includes investment in cash and cash equivalents.

The main draw of this asset class is its liquidity.

Cash is a business’s most liquid asset after all.

This makes them very accessible.

That said, there’s little to no growth when you invest in cash alone. Cash is also vulnerable to the effects of inflation.

Cash equivalents are investments that are readily convertible within 90 days or less.

Examples include short-term government bonds, treasury bills, commercial papers, etc.

While they offer some kind of returns, they’re usually lower when compared to investments that fall under a different asset class.

You invest in this asset class for liquidity, accessibility, and stability.

But if you’re looking for an investment that provides higher returns, then you may want to look at one that falls under the other asset classes.

Real Estate And Marketable Commodities

The real estate asset class includes investments in physical assets such as condominiums, apartments, motels, plots, commercial buildings, etc.

These assets rarely decrease in value. In fact, in recent years, the value of real properties just kept increasing.

On the other hand, the marketable commodities asset class includes investment in physical assets, but instead of real estate, it focuses on assets that retain their value over time.

Examples include precious metals such as gold and silver, livestock such as poultry and cattle, agricultural produce such as wheat and rice, etc.

These investments in physical assets offer protection from inflation.

Their value generally increases along with inflation, sometimes even more.

The downside is that they’re not as liquid as the other investments that fall under the other asset classes (in the case of real estate).

Even some marketable commodities may take a long time to sell (artworks and other collectibles).

Aside from that, what differentiates this class from the others is that they have an actual physical form.

They are not represented by a piece of paper or a digital certificate. For example, when you invest in a building, you’d actually get a building, not just a piece of paper that represents the building.

Futures And Other Derivatives

This asset class includes investments in instruments that derive their value from other instruments, assets, or an event.  

For example, the value of a stock option is a derivative of stocks.

Derivatives are a tricky beast to handle.

For the uninformed, they work like magic.

When you play your cards right, you can get something out of nothing.

But in actuality, derivatives are akin to betting on changes in the market conditions or fluctuations.

For example, you may invest in a futures contract where you pay for a commodity at a set price at a certain date in the future.

You’re essentially betting that the set price will be lower than the market price when the date to exercise the futures contract comes.

Do note that this is only a simple example of what a derivative can give you.

Derivatives are complex financial instruments, more complex than equities even.

As such, it isn’t suitable for beginner investors. To make the most out of derivatives, one must have extensive knowledge of how the market works.

Asset Class and Investing Strategies

Depending on an investor’s risk appetite, s/he may gravitate towards investments that belong to certain asset classes.

For financial advisors, asset classes help in creating investment strategies that fit the preferences of the investor.

The investor has an appetite for high-risk investments, and has the money to back them up?

Then let’s focus on investments that belong to asset classes that are high-risk but offer high rewards.

What if the investor wants to play it safe?

Then let’s focus on investments that belong to low-risk asset classes.

Understanding the different asset classes also helps in diversifying your investment portfolio.

With diversification, you can minimize the overall risks of your investment by putting your eggs in different baskets.

Do note that it doesn’t eliminate risk entirely.

Investing comes with inherent risk after all, and not even diversification can eliminate that.

Each asset class reacts differently to changes in the market conditions.

As such, there is typically little correlation between different asset classes.

So diversifying your investment portfolio will maximize profits while minimizing risks.

You also don’t have to worry if one asset class “loses” as your investments in the other classes can make up for it.

But you could also forego diversification and just invest in one particular instrument.

Do note though that you’ll be carrying the full risk of the investment losing.

But it could also mean that you’d receive maximum returns when it “wins”.

At the end of the day, asset classes aid an investor in designing their investment portfolio so that it fits his/her preferences.