More than half of all American households have an investment portfolio to some degree. Many of these families have invested in the stock market.
A smaller portion of people continues to own or invest in bonds directly. As of 2016, only a little over one percent of the population included bonds in their investment portfolios.
Stocks and bonds are both investments, but they fall under different asset classes. Why is this important to know? What are asset classes?
Continue reading to learn what asset classes are. Also, learn why all investors must understand asset classes.
What Is an Asset Class?
The term asset class refers to a grouping of investments. These investments are grouped because they have similar characteristics. They’re also subject to the same laws and regulations.
Asset classes include both tangible and intangible instruments. Included instruments can be bought and sold for income generation, whether for the short or long term.
What Are the Main Asset Classes?
There are three primary asset classes. These include:
- Equities (generally stocks)
- Fixed income (generally bonds)
- Money market instruments (also known as cash equivalent assets)
While these three were the only asset classes historically, many financial experts include other classes modernly. Not all investment professionals use these classes. As time continues, more are choosing to do so, and eventually, these may be included as primary asset classes.
These additional asset classes include:
- Real estate
Each of these groupings exhibits similar characteristics. They’re subject to the same regulations and usually provide similar cash flows. But why is it essential to understand asset classes?
Why Is This Important to Understand?
Understanding asset classes can allow investors to create a better wealth strategy. Investors and financial experts recommend a mix of asset classes for several reasons.
Firstly, a group of asset classes will generally produce a similar cash flow. This can help people better gauge how their finances will increase when considering the addition of a financial investment into an existing asset class.
Understanding asset classes is so vital because of the importance of diversification within an investment portfolio. By diversifying a portfolio, an investor reduces the risk of financial failure should one asset class decrease in value.
Let’s say, for example, someone has only invested in stocks. If the stock market, as a whole, drops in value, this can spell disaster. The person who only has stocks in their investment portfolio will find themselves significantly hurt financially.
But what if that same person had also invested in bonds and real estate? These additional investments provide a buffer against crashing stocks. When the stocks decrease in value, the financial impact is less significant if both bonds and real estate stay stable or increase.
Do You Have More Questions About What Are Asset Classes?
Asset classes are a group of investments with similar properties. They’re subject to the same regulations and usually provide a similar cash flow. Understanding asset classes allows people to make better decisions with their investment portfolios.
Do you have more questions about what are asset classes?
Check out our other blog posts. You’ll find several blogs on related topics that can help you dive deeper into the subject.