This blog post was written by Student Advisory Council member, Eddie Richardson.
Have you ever heard of an investment asset class? Asset classes are what is used to categorize different types of investments, and before you invest, you’ll want to make sure you understand the differences between various asset classes. Asset classes vary by risk, return, and accessibility. There are four main types of asset classes: equities, fixed income, real assets and cash. Read on to learn about each of these four categorizations.
Equities: Shares in companies have high-risk, high-reward potential
Equities (also known as stocks) are shares issued by a company which represent ownership in the company. When you invest in an equity, you buy a share of a company and become a shareholder. There’s a wide variety of ways to own shares of a company, from publicly traded shares to investments in privately held companies. Equities have the potential to make you money in two ways: capital growth through increases in the share price or income in the form of dividends, which are profits that are distributed from the company to its shareholders. However, neither of these is guaranteed and there is always the risk that the share price will fall below the level at which you invested. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.
Examples: stocks, mutual funds, exchange traded funds, private equity
Fixed Income: Fixed payments present low-risk, stable returns
Fixed income investments make fixed payments (income) on a principal investment, with the principal returned at a specific future date. Corporate bonds are the most common form of fixed income investment, but there are other types of fixed income investments such as government bonds, certificates of deposit, and money market funds. Bonds can offer stable returns, and are perceived to be lower risk than equities – although typically deliver lower returns over the long-term. However, there are still some risks associated with fixed income investments, such as changes in interest rates, credit quality, tax ramifications and more. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities backed by governments or credit rating agencies.
Examples: Corporate bonds, government bonds, certificates of deposit, money market funds
Real Assets: Physical assets present a medium-to-high return on investment depending on their intrinsic value
Real assets are based on tangible things, such as buildings or a barrel of oil. The most common types of real assets are property and commodities. Property refers to an investor owning an office, apartment or industrial complexes expressly to sell or rent for a return. Commodities refer to raw materials, such as oil, wheat or gold. These investments can appreciate in value- for example, an apartment building can increase in value as rents in an area increase. However, investing in real estate can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, and changes in interest rates. Similarly, commodity prices may increase as a result of supply and demand factors, however these types of holdings also are subject to risks. For example, regulatory factors affecting the market for oil can greatly harm potential investment returns.
Examples: office buildings, apartment complexes, oil, wheat, gold
Cash and Cash Equivalents: Cash equivalents present a low risk, defensive asset
Many investors hold cash as a way of maintaining liquid assets or simply providing safety and comfort in volatile times. Cash equivalents include cash-like products such as Treasury bills and commercial paper. A cash investment tends to be seen as a lower risk, lower return option than bonds or equities. It can be a useful tool for very risk‑averse investors or as a temporary home for money in between longer‑term decisions. However, because they offer lower rates of return, they are often not very useful for portfolios looking to optimize for long-term growth.
Examples: Commercial paper, Treasury bills, short-term government bonds
A robust investment portfolio usually contains a mix of all four of these asset classes. Deciding which asset classes you include in your portfolio, and how heavily you invest in each, should depend on your financial goals, time horizon and the level of risk you’re comfortable with.
