If you’re just learning how to invest money, the process can be intimidating. There are countless investment platforms to choose from, including robo-advisors and online brokers. There are also different types of accounts — and did we mention all the financial jargon to decipher?
The good news is there are many resources available to help you get familiar with the jargon, including articles and videos. If you’re here today because you’re wondering about asset classes, we’ve got you covered.
Here’s what asset classes are, how they work, and how you can use them as part of a strong investing strategy.
What is an asset class?
An asset class is a group of investments that functions similarly. Within an asset class, the investments also produce returns in similar ways. For instance, savings and money market accounts earn interest based on a percentage of the savings allocated to the account. The interest may be compounded daily or monthly.
When you invest, one key factor to consider is that some investment assets are liquid and others are illiquid. For instance, a money market account is liquid because you can access the funds in the account at any time and use that money to pay bills. On the other hand, illiquid assets could include real estate investments. Although the property can be sold, it can take several years for a property to appreciate in value. When a property owner decides to sell, it can take months until the transaction is completed and the owner of the real estate receives the proceeds of the deal. Investors should have a combination of both types of assets so they can access the money in the liquid accounts if needed.
There are four main asset classes:
- Cash equivalent/money market
- Fixed income
- Real estate/alternative assets
4 types of asset classes and how they work
Cash equivalent or money market
One type of asset class is a cash equivalent or money market account. It is one of the most common asset classes because many people use these accounts to save money for emergencies, daily expenditures, and bills.
A cash equivalent account is often referred to as a savings account or a money market account. Brick-and-mortar banks, online banks, and credit unions may offer these accounts. Financial institutions determine an interest rate and pay the customer based on the account balance or amount of money put into the account. Many people have a savings account to hold the money that is leftover after they pay bills.
A money market account is a savings account that has the capabilities of a checking account. It usually offers a higher interest rate than a typical savings account and allows customers to write a preset number of checks each month.
Both savings and money market accounts offer debit cards, which consumers can use to make purchases in a store or online.
Equities, commonly referred to as stocks, provide people an opportunity to own a small percentage of a company. Investors can buy and sell shares of stock directly through an online brokerage. Certain brokerages, like Stash, also offer the option to invest in fractional shares, or portions, of a stock share. Another option is to buy and sell stocks via a financial advisor that manages money for investors.
One common way to own a basket of stocks in a particular industry, such as tech stocks, is to invest in an exchange-traded fund or a mutual fund. Both ETFs and mutual funds typically either follow a benchmark or are actively managed by a portfolio manager who chooses the stocks to buy and sell within the fund.
Fixed-income or debt (bonds)
Fixed-income assets include different types of bonds. Bonds are known for producing steady income, so they’re often preferred by investors who are close to retiring, have stopped working, or want a lesser risk than stocks.
Investors can choose from several types of bonds, including corporate bonds and government bonds, such as municipal bonds and Treasuries.
Corporate bonds are issued by companies so they can pay for acquisitions, growth, expansions, and to refinance existing debt. In return, the companies provide investors with a set percentage yield, plus repayment of the principal amount of money.
Bonds can also be purchased through a mutual fund or ETF so an investor does not have to choose a single company, state, or city. By investing in bonds through a mutual fund or ETF, investors can build a diversified portfolio by investing in a small portion of hundreds or thousands of bonds.
Real estate and other investment assets
Real estate is an asset many people are familiar with. Investors can allocate their money into residential properties, like single-family or multifamily homes, or commercial property, such as shopping centers or office buildings. Some people might choose to buy a vacation home to earn money by renting out the property. Other people buy land used for farming or for commercial purposes.
The price of real estate is often harder to predict, so investing in real estate can be risky. Some real estate owners choose to hold onto the property for several years, whereas others buy a house to fix up and sell quickly.
Real estate can be a riskier asset to own because buyers and sellers may not always agree on an asking price. A potential buyer has to be approved for a mortgage, and there are government rules to follow, such as what you can build on a piece of land or building size restrictions.
Investors might consider buying alternative investments, like precious metals, cryptocurrency, or items such as collectibles, wine, or expensive automobiles. Platforms like Masterworks even let you invest in fine art. These assets are sometimes purchased from individuals or auction houses.
What to consider before you invest
Before you decide to invest, carefully consider your risk tolerance and investment style. Deciding how much money you’ll allocate toward investing is also important.
Some assets, such as stocks, can be riskier to own because the price can fluctuate rapidly and result in gains or losses. While all investments come with risk, bonds are generally considered to be less risky for investors and are often allocated to retirement accounts such as 401(k)s and IRAs.
Thinking about your investment style is also important. Some people prefer a more hands-on approach to investing, whereas others prefer to rely on a trusted financial advisor or one of the best investment apps to manage their investments. Similarly, some prefer to invest in individual stocks or fractional shares of stock; others prefer to diversify with ETFs or mutual funds.
Creating a budget for investing is also important. Although many brokers no longer charge fees for buying and selling assets, some may charge a management fee. In addition, some may have a minimum investment requirement. These are all important things to think about before you choose how and where to invest.
Why diversification is important
Diversification is one of the most important factors when it comes to investing. With a diversified investment portfolio, you may see less volatility in prices and could experience less risk. In short, diversifying your asset allocations can help offer some protection if you start investing during a recession or another turbulent time.
FAQs about asset classes
What are the major asset classes?
The four major asset classes include cash and cash equivalents, stocks, bonds, and real estate. Many investors own a mixture of investments in different asset classes. Some of these asset classes are more liquid than others.
Are equities a good investment?
Investing your money in equities can be a good investment, especially over a longer period of time. There is always some risk involved because it can be difficult to predict the future earnings of a company. The price of a stock can rise or fall due to various factors such as market sentiment (how investors feel about the market based on recent news and other factors), future earnings, and current market and economic conditions.
Are bonds a good investment?
Bonds are often perceived as a lower-risk investment as compared to equities. However, investors can still lose money by investing in bonds. Government bonds may be subject to some of the same market conditions as stocks. Corporate bonds could be riskier if a company faces problems with cash flow or bankruptcy.
The bottom line
Learning about the different asset classes can help new investors learn where they might want to allocate their money. It’s also important to consider your investment style and your risk tolerance. Putting money into different asset classes can help you diversify your portfolio and potentially reduce your risk. And although some investors are hands-on types of people who want to manage their own investments, others prefer to rely on the expertise of financial advisors.
FinanceBuzz is not an investment advisor. This content is for informational purposes only, you should not construe any such information as legal, tax, investment, financial, or other advice.
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