An asset class is a classification of investments based on common traits, behaviors and laws.
The main categories of investment assets are stocks (equity), bonds, real estate and cash equivalents. You can further break these general categories into “sub-classes” or specific types of stocks, bonds, and so forth. This will allow you to further tailor your portfolio to meet your specific needs. Keep in mind that asset classes can overlap in some cases. For example, a REIT is a hybrid that can be considered both an equity and a real estate investment.
When considering asset classes, it’s important to note that you must diversify your portfolio across multiple asset types and classes. While some asset classes tend to move up and down together, there are some that are not correlated. In other words, they may move in opposite directions at the same time. This diversification will help to minimize risk while increasing long-term returns.
Bonds are often considered a “safe” investment, but they can be very risky and volatile. There are many types of bonds available depending on their risk level, the amount of interest they pay, and the length of expiration. These factors affect their price and risk ratio and should be carefully considered before purchasing a bond. Government bonds, corporate bonds, municipal bonds and Treasury Inflation-Protected Securities (TIPS) are all examples of fixed-income investments.
Commodities are raw materials that are often used as a source of fuel or food. Examples include corn, wheat, gold and oil. While some commodities may be used in manufacturing, most are traded on commodity exchanges. Gold is an exception, as it’s usually purchased as a store of value or a hedge against inflation. These commodities fluctuate in price, and generally follow the direction of the economy.
Cash and cash equivalents have historically been regarded as the safest assets, whereas shares have historically been among the riskiest. In either scenario, there may be exceptions. Some stocks are safer than others, though generally speaking, rising interest rates hurt all stocks. Cash can be unusually risky at times, such as when inflation is skyrocketing, and some stocks can be safer than others.
Cash is not considered a good investment, given the risks associated with inflation, whereas a broadly diversified portfolio of stocks has historically helped investors preserve their purchasing power.
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