An asset class is a group of similar investment vehicles. Different classes, or types, of investment assets – such as – are grouped together based on having a similar financial structure. They are typically traded in the same financial markets and subject to the same rules and regulations.
Understanding Different Asset Classes
There’s some argument about exactly how many different classes of assets there are. However, many market analysts and financial advisors divide assets into the following five categories:
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Stocks or equities – Equities are shares of ownership issued by publicly-traded companies. They are traded on stock exchanges such as the NYSE or NASDAQ. You can potentially profit from equities either through a rise in the share price or by receiving dividends. The asset class of equities is often subdivided by into small-cap, mid-cap, and large-cap stocks.
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Bonds or other fixed-income investments – Fixed-income investments are investments in debt securities that pay a rate of return in the form of interest. Such investments are generally considered less risky than investing in equities or other asset classes.
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Cash or cash equivalents, such as money market funds – The primary advantage of cash or cash equivalent investments is their liquidity. Money held in the form of cash or cash equivalents can be easily accessed at any time.
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Real estate or other tangible assets – Real estate and other physical assets are considered an asset class that offers protection against inflation. The tangible nature of such assets also leads to them being considered as more of a “real” asset. In that respect, they differ from assets that exist only in the form of financial instruments, such as derivatives.
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Forex, futures and other derivatives – This category includes futures contracts, spot and forward foreign exchange, options, and an expanding array of financial derivatives. Derivatives are financial instruments that are based on, or derived from, an underlying asset. For example, stock options are a derivative of stocks.
Additional Factors in Classifying Assets
It’s difficult to classify some assets. For example, suppose you’re investing in stock market futures. Should those be classified with equities, since they’re essentially an investment in the stock market? Or should they be classified with futures, since they’re futures? Gold and silver are tangible assets, but are frequently traded in the form of futures or options, which are financial derivatives. If you invest in a , should that be considered an investment in tangible assets, or as an equity investment since REITs are exchange-traded securities?
The diversity of available investments also creates complications. Exchange-traded funds (ETFs), for example, trade on exchanges, just like stocks. However, ETFs may be composed of investments from one or more of the five basic asset classes. An ETF that offers exposure to the energy market may be composed of investments in oil futures and in stocks of oil companies.
Assets may also be categorized by location. Market analysts often view investments in domestic securities, foreign investments, and investments in emerging markets as different categories of assets.
Other asset classes include collectibles, hedge funds or private equity investments, and cryptocurrencies such as Bitcoin. These asset classes are a bit more off the beaten path. For that reason, they are sometimes classified together under the heading of “alternative investments”. Generally speaking, the more “alternative” an investment is, the more illiquid and the riskier it tends to be.
Asset Classes and Diversification
Good news! – You don’t really have to know for certain which asset class a specific investment falls into. You just need to understand the basic concept that there are broad, general categories of investments. That fact is important because of the concept of diversification. Diversification is the practice of reducing your overall risk by spreading your investments across different asset classes.
There is typically little correlation, or an inverse or , between different asset classes. During periods of time when equities are performing well, bonds, real estate, and commodities may not be performing well. However, during a bear market in stocks, other assets, such as real estate or bonds, may be showing investors above-average returns.
You can hedge your investments in one asset class, reducing your risk exposure, by simultaneously holding investments in other asset classes. The practice of reducing investment portfolio risk by diversifying your investments across different asset classes is referred to as asset allocation.
Asset Allocation and Risk Tolerance
The other reason to have a basic understanding of asset classes is just to help you recognize the nature of various investments that you may choose to trade. For example, you might choose to devote all, or nearly all, of your investment capital to trading futures or other financial derivatives such as . But if you do, you must at least be aware that you have chosen to trade a class of assets that is usually considered to carry significantly more risk than bonds or equities.
The extent to which you choose to employ asset allocation as a means of diversification is going to be an individual decision that is guided by your personal investment goals and your risk tolerance. If you’re very risk-averse, then you may want to invest only in relatively safe asset classes. You may aim to diversify within an asset class. Stock investors commonly diversify by holding a selection of large-cap, mid-cap, and small-cap stocks. Alternately, they may seek diversification through investing in unrelated market sectors.
On the other hand, if you’re blessed with a high-risk tolerance and/or with having money to burn, you may care very little about diversification, and just be focused on trying to identify the asset class that currently offers the highest potential profits.
Other Related Terms
Thank you for reading CFI’s guide on Asset Class. Browse all the terms and definitions in our , or read up on these relevant articles below:
Asset Class Investopedia
From Investopedia
An asset class is a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations. Asset classes are thus made up of instruments that often behave similarly to one another in the marketplace.
Asset Class Summary
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An asset class is a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations.
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Equities (e.g., stocks), fixed income (e.g., bonds), cash and cash equivalents, real estate, commodities, and currencies are common examples of asset classes.
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There is usually very little correlation and in some cases a negative correlation, between different asset classes.
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Financial advisors focus on asset class as a way to help investors diversify their portfolios.
Understanding Asset Classes
Simply put, an asset class is a grouping of comparable financial securities. For example, IBM, MSFT, AAPL are a grouping of stocks. Asset classes and asset class categories are often mixed together. There is usually very little correlation and in some cases a negative correlation, between different asset classes. This characteristic is integral to the field of investing.
Historically, the three main classes have been (stocks), fixed income (bonds), and or money market instruments. Currently, most investment professionals include , , futures, other financial derivatives, and even cryptocurrencies in the asset class mix. Investment assets include both tangible and intangible instruments which investors buy and sell for the purposes of generating additional income, on either a short- or a .
Financial advisors view as asset class categories that are used for purposes. Each asset class is expected to reflect different risk and return investment characteristics and perform differently in any given market environment. Investors interested in maximizing return often do so by reducing portfolio risk through asset class diversification.
Financial advisors will help investors diversify their portfolios by combing assets from different asset classes that 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 return.
Asset Class and Investing Strategy
Investors looking for employ investment strategies focused on achieving alpha 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 link criteria to performance and/or valuation metrics such as growth (EPS) or the (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.
Asset Class Types
Equities (stocks), bonds (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 real estate, and valuable inventory, such as artwork, stamps, and other tradable collectibles. Some analysts also refer to an investment in hedge funds, venture capital, crowdsourcing, or cryptocurrencies as examples of alternative investments. That said, an asset’s illiquidity does not speak to its return potential; It only means it may take more time to find a buyer to convert the asset to cash.
What Are the Most Popular Asset Classes?
Historically, the three main asset classes have been equities (stocks), fixed income (bonds), and cash equivalent or money market instruments. Currently, most investment professionals include real estate, commodities, futures, other financial derivatives, and even cryptocurrencies in the asset class mix.
Which Asset Class Has the Best Historical Returns?
The stock market has proven to produce the highest returns over extended periods of time. Since the late 1920s, the [CAGR](https://www.investopedia.com/terms/c/cagr.asp#:~:text=Compound annual growth rate (CAGR,year of the investment’s lifespan.) (compounded annual growth rate) for the S&P 500 is about 7.63%, assuming that all dividends were reinvested and adjusted for inflation.1 In other words, one hundred dollars invested in the S&P 500 on Jan. 1, 1920, would have been worth about $167,500 (in 1928 dollars) by Dec. 31, 2020. Without adjusting for inflation the total would have grown to more than $2.2 million in 2020 dollars. By comparison, the same $100 invested in 10-year Treasuries would have been worth only a little more than $8,000 in today’s dollars.
Why Are Asset Classes Useful?
Financial advisors focus on asset class as a way to help investors diversify their portfolios to maximize returns. Investing in several different asset classes ensures a certain amount of diversity in investment selections. Each asset class is expected to reflect different risk and return investment characteristics and perform differently in any given market environment.
What Is an Asset Class Breakdown?
An asset class breakdown provides the percentages of core asset classes found within a mutual fund, exchange-traded fund, or another portfolio. Asset classes (in microeconomics and beyond) generally refer to broad categories such as equities, , and commodities. Often, sub-asset classes may be reported in concentrated portfolios or for more granular detail.
Key Takeaways
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An asset class breakdown demonstrates how certain core asset classes are accounted for in an investment portfolio.
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Asset classes can include stocks, bonds, commodities, cash, real estate, and currencies.
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Asset class breakdowns help investors understand the nuts and bolts of their portfolios, management’s goals, the distribution of funds, and the inherent risks.
Understanding Asset Class Breakdowns
An asset class breakdown represents the distribution of assets in a portfolio. Breakdowns are calculated by dividing the market value of a particular asset class’s holdings by the fund’s total assets. Comprehensive asset class breakdowns are typically provided to help an investor understand the fund’s investment objective and risk management strategy.
Investing by asset class is a primary way for investors and professional portfolio managers to manage risk. Asset classes may include cash, fixed income, equities, , and real estate. Each has its risk characteristics and return opportunities. Fixed income and equity investments are typically asset classes used for core holdings. Both have multiple investment options, with fixed income used for more conservative investments and equities used for more aggressive allocations.
Cash investments are the most conservative and can include high-yield savings accounts and money market funds.
Types of Sub-Asset Class Breakdowns
breakdowns are also often used in due diligence fund reporting and can provide similar support for investors. Sub-asset class breakdowns may be used when a fund is highly concentrated in one asset class.
Fixed income sub-asset class breakdowns can include a wide range of loans, , corporate bonds, and municipal bonds. Equity sub-asset classes can consist of special categories such as real estate investment trusts (REITs) and master limited partnerships (MLPs). They may also include market capitalization breakdowns such as small-cap, mid-cap, and large-cap or investment styles such as and . Investing in international investments can add sub-asset class components for investments.
Example of Asset Allocation Breakdown
60/40 funds are a popular choice for investors seeking balanced asset allocation fund options. The BlackRock 60/40 Target Allocation Fund provides one example for investors. This Fund uses a fund-of-funds approach to provide a 60/40 asset class breakdown between equity and fixed income.
Individual fund holdings are used to provide exposure to various sub-asset classes, including U.S. stocks, developed market stocks, international stocks, and 7- to 10-year Treasury bonds. BlackRock’s asset allocation funds include the 40/60 Target Allocation Fund, 80/20 Target Allocation Fund, and the 20/80 Target Allocation Fund.
Special Considerations
The asset class breakdown is often used in marketing the fund to investors since it is a simple way to present the approximate of a fund. Asset allocation funds will generally vary by asset mix, often marketed as conservative, moderate, or aggressive funds.
Higher equity exposure is typically found in more aggressive growth funds. Moderate funds tend to have a balanced asset allocation approach that is evenly weighted between equity and fixed income. Overall, modern portfolio theory suggests that can be a crucial determinant for total return potential and risk characteristics.
