Last editedJul 20212 min read
With so many different financial instruments and vehicles making up the financial industry as a whole, it makes sense for these instruments to be placed into various asset classes, i.e., easy-to-follow asset categories. A basic understanding of asset classes will go a long way to helping you choose instruments that will best suit your investment strategy.
What is an asset class?
Let’s begin with an asset class definition. An asset class is basically a group of similar investment types. It’s made up of financial instruments that behave in the same way within the marketplace. Instruments in specific asset classes also have to adhere to the same laws and regulations as one another. Essentially, asset classes are comparable securities – for example, when it comes to asset classes, DIS, TSLA, and AAPL can all be considered to fall into the “stock” asset class.
Types of asset classes
Depending on which asset class definition you follow, the total asset classes list can vary between three and seven different asset classes. However, the most accepted asset class list consists of money market instruments, stocks (equities), and bonds (fixed income). In addition, some people consider commodities, futures, cryptocurrency, and even real estate to be financial asset classes.
Asset classes list
If you speak to any financial advisor, they’re likely to use asset categories as a means of helping you diversify your portfolio. Financial advisors will generally focus on five key asset classes. Each of these five asset classes perform differently in a given market state, while also exhibiting different risk/return characteristics.
Of all the financial asset classes, equities are probably the most common for retail investors to focus on. “Equity” refers to the return that shareholders would receive if a company were to liquidate all of their assets and pay off any debts. Shareholder's equity represents the owner’s stake in the company – it’s a simple calculation of company assets minus total liabilities.
Bonds are fixed-income investments in debt securities, such as treasury notes and bills. Instruments in this asset class pay a return in the form of interest. Generally speaking, bonds are less risky than other asset classes.
When it comes to asset categories that are all about liquidity, money market funds are the way to go. Instruments such as cash, high-credit-rating securities, and debt-based securities will fall into this asset class. Money market funds aim to offer tons of liquidity at very low risk.
Real estate asset classes
When talking about real estate asset classes, we mean more than just property. Physical assets that may be considered “tangible assets” also fall within this asset category. To most people, these are “real” assets. Financial advisors usually regard real estate asset classes as a form of protection against inflation.
Other derivatives, forex and futures
This category features multiple asset types – it’s essentially “everything else”. Forex refers to various contracts on foreign exchange trades, while derivatives refer to financial instruments that are based on an underlying asset such as an exchange-traded fund (ETF) or stock options. Some financial advisors may also consider cryptocurrencies to fall within this last type of asset class.
Asset classes and strategy
Asset classes are tools for creating an investment strategy, as they can serve to diversify your portfolio. Because asset classes are used for diversification – thereby reducing your overall level of risk – you’ll find almost no correlation between the different asset classes.
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