What Are Asset Classes? More Than Just Stocks and Bonds

Asset Classes

When entering the investment world, most people think of just two things: stocks and bonds. And be that as it may, did you know that there are several investment opportunities? We call this increasingly wider spectrum of asset classes.

Understanding what an asset class is, how it performs, and why it matters will help you design a balanced and rational investment portfolio. So, let’s get into the concept one step at a time.

What Is an Asset Class?

Think of the fruit basket that may contain apples, oranges, and bananas. Similarly, an investment portfolio could consist of the various asset classes of stocks, bonds, real estate, gold, or even cryptocurrencies.

Depending on the market, economic changes, or investor sentiment, each asset class behaves differently. Hence, one can create mainly to manage risk for better returns through this knowledge of the asset classes.

Understanding Asset Classes

An investor does not put all his/her money into one kind of investment because none performs the best every year. One can reduce risk more by the combination of multiple asset classes, meaning diversification.

Different asset classes behave differently by nature and therefore rise or fall for varied reasons. For example:

• Stock prices tend to go up as companies perform well.
• Bond prices either stay steady or go up when investors seek safety.
• Rental income may accrue from real estate irrespective of daily market noise. 

The very existence of such variety helps to insulate your portfolio during market rises and falls.

Types of Asset Classes

Here are the popular asset classes every investor must know about:

1. Equities (Stocks)

Ownership rights over companies are given. Stocks may offer high growth and capital gains but are highly volatile. Equities have historically given strong returns in the long run.

2. Fixed Income (Bonds) 

Bonds are loans. You lend money to governments or corporations, and in return, they pay you interest at regular intervals. The safety of bonds is high compared to stocks, but they bear lower returns.

3. Real Estate

The investment is made in properties, either directly by the purchase of land/buildings, or indirectly through Real Estate Investment Trusts. Real estate may earn rental income and appreciate.

4. Cash and Cash Equivalents-

These include savings accounts, fixed deposits, or short-term government securities. They offer liquidity and safety, but from a returns standpoint, they are very poor.

5. Alternative Asset Classes

Now, that is interesting. Alternative asset classes include:

• Commodities, such as gold, oil, or agricultural products
• Hedge funds
• Private equity
• Venture capital
• Cryptocurrencies
• Art and collectables

These investments usually do not move together in the same direction as stocks and bonds; hence, they offer the additional benefit of diversification.

Asset Class and Investing Strategy

Now that you know asset classes, what do you do with that information?

The method of investing is against:

• The financial goal you are setting (buying a house, educating your child, or living comfortably through retirement)
• The risk you can tolerate
• The investment time horizon, or for how long you intend to stay invested.

For example:

• A young person planning for 30 years of investing may go for greater equity holding.
• A person closer to retirement will move toward more bonds and cash for safety.
• This is what asset allocation is all about: how much of each asset class you want in your portfolio.

The right asset allocation, when combined with correct risk tolerance, keeps you calm during volatility and smoothens the path for your goal.

Additional Factors in Classifying Assets

Asset classes can also be broken down further. For example:

• Stocks are either large-cap, mid-cap, or small-cap
• Bonds can be government or corporate bonds; they can be short-term to long-term.
• Real estate can be residential, commercial, or industrial.

Liquidity (how fast you can sell), income generation (through dividends, interest payments, rents, and so on), and riskiness are other dimensions along which assets can be classified for selection.

What Are the Most Popular Asset Classes?

The most common asset classes worldwide for retail investors include:

• Equities (Stocks)
• Bonds (Fixed Income)
• Real Estate
• Cash and Cash Equivalents
• Gold (for a traditional hedge)

Alternative asset classes are, however, often explored for diversification and return prospects by the more sophisticated investors and institutions. 

Which Asset Class Has the Best Historical Returns?

Theoretically, stocks produce much better returns than any class of investment over a longer period of time. With examples like the S&P 500 in the US and the Nifty 50 in India, long-term growth of several decades has far outstripped the returns from bonds or cash. 

Returning means more risk and quicker price movements. Hence, a balanced portfolio would consist of many asset classes that can provide for capital appreciation while maintaining stability.

Example: How It All Comes Together

Let’s look at Riya, a 30-year-old IT professional. Her goals are to grow wealth for her retirement and buy a house in 10 years.

• She goes ahead to invest 60% of her portfolio in equities (growth).
• She keeps 20% in bonds for stability and income.
• She keeps 10% in real estate, as it means rental income and appreciation.
• She has 10% set aside in cash equivalents for emergencies.

If feeling adventurous, she may throw in 5% in gold or cryptocurrencies as alternative asset classes.

A diversified allocation like this ensures she can continue to sleep if stocks happen to drop all of a sudden: the bonds, real estate, and cash ease the fall.

Also, check – Multi-Asset Allocation Funds

Conclusion

Understanding what constitutes an asset class and how different types of assets operate gives an investor an idea of how to create an investment portfolio that best aligns with her goals. Yet, no asset class is perfect all the time- markets undergo cycles, and what may be booming today may likely underperform tomorrow. 

The trick is not to chase the asset class that is “best” that very year. Instead, create a sensible combination, one that fits with your goals and your level of risk comfort.

So, whether you are entering the investing environment for the first time or are a seasoned investor, remember: Diversify, allocate, and review. That’s what will actually build wealth, able to weather any storm.

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Disclaimer – This article is for educational purposes only and does not intend to substitute expert guidance. Mutual fund investments are subject to market risks. Please read the scheme-related document carefully before investing.