Asset classes explained
What is an ‘Asset Class’
An asset class is a group of securities that exhibits similar characteristics, behaves similarly in the marketplace and is subject to the same laws and regulations.
Overall, there are three main types of asset class:
- Stocks (or equities)
- Bonds (or fixed income)
- Cash (or cash equivalents).
BREAKING DOWN ‘Asset Class’
Each asset class is expected to reflect different risk and therefore, a different return and each performs differently in any given market environment (where interest rates rise and fall). A common action taken by investors that have an interest in achieving the maximum rate of investment return will often reduce the risk to their investment portfolio risk through asset class ‘diversification’.
It is common for financial advisors to use asset class as a way to help investors diversify their portfolio, or to manage the rate of investment risk while maximising the rate of return potential. Different asset classes have different cash flows streams and varying degrees of risk. Investing in several different asset classes ensures a certain amount of diversity in investment selections. Diversification reduces risk and increases your probability of making a positive return.
Asset Class Types
Stocks (or equities); bonds, or fixed-income securities; cash, or marketable securities; and commodities are the most liquid asset classes and therefore the most quoted asset classes. There are also alternative asset classes such as property, artwork, stamps and other tradable collectibles. Some analysts also refer to an investment in hedge funds, venture capital or even bitcoin as examples of alternative investments. The more alternative the investment, in general, the less liquid it will be (the less ‘liquid’ means the more difficult it can be to see if you need to sell in a hurry). But remember, an illiquid or liquid asset does is not a measure for how well the asset may generate a return on the original investment.
Asset Class and Investing Strategy
Investors looking for a high rate of investment return employ investment strategies focused on achieving those returns. Investment strategies can be tied to growth, value, income or a variety of other factors that help to identify and categorize investment options according to a specific set of criteria. Some analysts may link link criteria to performance and/or valuation metrics such as earnings-per-share growth (EPS) or the price-to-earnings (P/E) ratio. Other analysts are less concerned with performance and more concerned with the asset type or class. An investment in a particular asset class is an investment in an asset that exhibits a certain set of characteristics. As a result, investments in the same asset class tend to have similar cash flows.