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What is an asset class?
An asset class is a group of securities that share similar characteristics, perform comparably in the marketplace, and are governed by the same laws and regulations. Major asset classes include stocks, bonds, cash, real estate and commodities.
Alternative investments include art, stamps and other collectibles. Some analysts consider venture capital, bitcoins and hedge funds to be alternative assets as well.
Asset classes often are mixed together to diversify an investor’s portfolio and reduce its volatility. Each asset offers different risk and return characteristics and responds differently in the market. Asset classes react differently to news. For example, a piece of news may be positive for stocks, negative for bonds, but not have any impact on cash or real estate.
Historically, stocks provide the highest return of all the asset classes but also are the most volatile. While bonds and annuities provide lower returns than stocks, they’re less volatile.
Cash and short-term liquid securities, such as government issued securities and CDs, are considered the safest investment. Generally, real estate’s value is more stable than that of stocks but can also rise and fall sharply.
Investors select assets based on different factors, including growth, value and income. Some investors analyze the investment’s performance or valuation metrics such as the price-to-earnings (P/E) ratio or earnings per share (EPS).
Other investors seek out particular types of assets, based on the asset’s behavior in certain environments. Since investments within a certain asset class behave similarly, they usually offer similar cash flow.
Generally, alternative assets are less liquid. These assets often take longer to sell. However, an asset’s lack of liquidity does not reflect its potential return.
Asset class example
Chris has $100,000 and wants to diversify his portfolio to reduce its volatility. With help from his financial adviser, he invests $40,000 in stocks, $20,000 in bonds and $20,000 in short-term CDs while putting $20,000 down on an investment property. Chris is now invested in four asset classes.
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