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What is an investment asset class?
Learn about the different categories of investment assets and how they can help diversify your portfolio.
Once you start thinking about investing, you’ll hear the term “asset class” come up a lot. Put simply, an asset class is a group of similar assets or investments. The difference between the main asset classes when building your portfolio will affect your investment returns and your risk level.
What are asset classes?
Asset classes are groups of assets that are similar. While US stocks, international stocks, blue-chip stocks, stocks from emerging markets like India, industrial stocks, technology stocks and mining stocks are all different stocks, they belong to the same class. This is because they are similar in the way they are bought and sold through an exchange, are regulated in the same way and all have similar tax implications.
What are the main asset classes?
There are 5 main asset classes:
Equities include all stocks and funds listed on a public exchange like the S&P 500 or the NASDAQ. These are publicly listed companies, and when you buy shares in these companies, you own a portion of it. Equities are often considered to be the highest-risk asset class.
2. Fixed-income securities and debt
Fixed-income assets offer a fixed rate of return, like bonds. Bonds are essentially a form of loan used by both companies and governments when they need to borrow money. Investors who lend their money will earn a preset, fixed interest rate on that money.
3. Cash and money market
This includes property investments in residential homes and commercial property — like major offices or industrial buildings. This is known as unlisted property, as it’s not bought and sold on an exchange like stocks and bonds are.
However, you can invest in listed property with a managed fund, investing in a range of properties. Although you access listed property on an exchange, it’s still considered part of the property asset class, rather than equities.
5. Alternative assets
Alternative assets are harder to identify, but they typically include assets that don’t fit into any of the above classes. For example, investments made into a private company — one that isn’t listed on an exchange — would be classed as an alternative asset. Another example is collectibles like antiques, art or a stamp collection.
Commodities like gold and other precious metals, grains and other agricultural products are sometimes included in the alternative asset class. You can purchase these directly or through exchanges. Additionally, currencies — and now cryptocurrencies) — are sometimes classified as an asset class, and are traded on their own foreign exchange market.
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Defensive vs. growth assets
We can group these 5 asset classes further into either defensive or growth assets. Defensive assets are lower risk and often offer investors a level of guaranteed income. Growth assets are riskier and typically aim to achieve capital growth over the longer term rather than income over the short term.
While returns are never guaranteed, it’s expected that high-risk growth assets will outperform lower-risk, defensive assets over the long term.
- Fixed income
- Alternative assets
Investing for income vs. capital growth
You could also divide the assets up depending on whether you’re investing for income or capital growth. Income assets provide ongoing income while you hold the asset. Capital growth assets may not provide any income for the short to medium term, but the investor hopes it will grow so when it’s sold to make a profit.
One asset class can include both income and capital growth assets. Let’s look at stocks as an example. An established blue-chip stock like Coca Cola or IBM that profits every year and consistently pays a large dividend to its shareholders is classed as an income asset, as it offers value while you’re holding it. However, stock in a newly listed tech startup that pays no dividends are classed as a capital growth asset. Shareholder buys it with hopes it’s value will increase over the longer term.
What is an underlying asset?
You’ll often hear the term “underlying asset” in relation to some investment products like exchange-traded funds (ETFs), mutual funds and derivatives like options and futures. These products all track the value and performance of a particular set of assets, known as the underlying assets, often even if you don’t own that asset.
Let’s look at ETFs, for example. These are types of funds that track the performance of a basket of assets — often stocks that belong to a market index or futures contracts. So a S&P 500 ETF will track the S&P 500 index, which is the value of the top 500 companies in the nation. If you invest in the ETF, you’ll get exposure to these 500 stocks (the underlying assets) without actually owning any of them directly.
Why should I invest in a range of asset classes?
Each asset class offers a different level of risk, and aren’t affected by the same market conditions. This means factors that might make stock prices fall or rise could have little impact on other asset classes like cash and property. Since they rise and fall at different times, investing in a range of asset classes can help make your portfolio less volatile.
How to find the right mix of assets for your portfolio
When designing your portfolio, take the following factors into consideration.
- Your risk tolerance. If risky assets are going to keep you awake at night, it might be best to invest in asset classes that are lower risk.
- Your income and growth goals. Why are you investing? Do you want to earn a regular income stream now or are you investing for well into the future?
Understanding the various asset classes can help you build the right portfolio. When you’re ready, compare your investment options and check out the online trading accounts that fit your investing profile and goals.
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