Major Asset Classes Explained

Creating a balanced investment portfolio requires knowledge of how investments work. A good understanding of asset classes is an important part of creating a balanced portfolio and determining which assets to invest in.

In this article, we’ll take a look at different major asset classes. We’ll also talk about risk and how it factors into your investment and financial planning strategies.

An asset class is a grouping of investment vehicles that share similar characteristics. Three main asset classes are equities (stocks), fixed-income investments (bonds), and cash (and equivalents). Financial advisors help clients to diversify their portfolios by investing in assets from different asset classes.¹

The list of asset classes and sub-classes has grown in recent years with the launching of new financial products. Historically, there have been three main asset classes: stocks, bonds, and cash (and equivalents). Today, many investment professionals include more investments in the asset class mix.

They are listed below, along with their relevant sub-classes that are commonly used in portfolio construction:

• Cash and Cash Equivalents: Savings, treasury bills, and money market accounts are examples of cash and cash equivalents. The common denominator for each of these is their liquidity. They can provide cash any time you need it.²
• Fixed Income Securities: These are a preferred investment for risk-averse individuals or companies. Bonds are a fixed-income security. They provide a steady fixed income, typically without the risk associated with equities.³
• Stocks and Equities: Stocks, also known as equities, are shares of publicly traded companies that are traded on stock exchanges such as the NYSE (New York Stock Exchange).⁴
• Alternative Investments: This asset class has expanded in recent years. Alternatives include the following sub-asset classes, although some investors may consider these subclasses to be standalone asset classes:
  
  
  • Real Estate
  • Foreign Currency (FOREX)
  • Cryptocurrency
  • Hedge Funds
  • Private Equity Funds
  • Commodities (gold, silver, energy, and agriculture)
  • Options / Derivatives
  • REITs
  • Hard assets (art, stamps, wine, etc.)

Some of these are high-risk, complex investments. It’s advisable to speak with a professional financial advisor if you’re considering any alternative investment.

There are several schools of thought on how to diversify your portfolio. Modern portfolio theory (MPT), developed in 1952, is one popular passive investing strategy that is still in use today. MPT is a method for selecting potential investments in order to maximize their returns within a given level of risk.⁵ Although post-modern portfolio theory (PMPT) is an attempt to improve MPT by minimizing downside risk,⁶ (a term for the risk of a loss in an investment, as opposed to the symmetrical likelihood of a loss or gain).⁷

No matter which theory you subscribe to, there are some universal tips for investors who are looking to diversify their portfolios.⁸

• Don’t put all of your money into one stock or sector.
• Consider adding in index funds or fixed-income funds.
• Continually add to your investments.
• Know when to exit.

It’s important to make investment decisions based on your risk tolerance.