If you’re just getting started with investing, you’ll quickly discover several asset classes to choose from when putting together your investment plan.
Since all plans have distinct features, as an investor, you should be aware of the advantages and disadvantages of each investment type – also known as an asset class. Here’s a short rundown of the major investments and what you need to know about them to help you make informed investment decisions.
Understanding Different Asset Classes
There has long been debate about how many different types of assets there are. Suffice to say that many market analysts and financial consultants split these assets into five categories.
Stocks or Equities
Historically, trading stocks have had the highest risk and highest returns among the three major asset classes. For example, many large companies have lost money once every three years on Stocks (on average). And it’s worth mentioning that the losses have been pretty big at times.
Conversely, investors willing to endure stock market turbulence for extended durations have usually reaped substantial positive returns as a reward. Stocks are indeed the company portfolio’s “heavy hitters,” with the highest growth potential as an asset class.
Bonds or Other Fixed-Income Investments
Bonds tend to be less volatile than stocks, but their returns tend to be lower, too. As a result, investors approaching financial goals could increase their bond holdings relative to their stock holdings.
Despite bonds’ lower growth potential compared to stocks, the decreased risk of owning more bonds is appealing to investors. You should note, however, that some types of bonds are comparable to stocks in that they may provide big returns.
Currency or Cash Equivalents as an asset classes
The major benefit of cash or cash equivalent assets is their liquidity. Money in the form of cash or other currency equivalents is conveniently accessible as well, whether you keep these assets in your bank account or with your safe or trade Forex.
Real Estate or Other Tangible asset classes
Real estate and other physical assets, such as machinery and gold, are common anti-inflation asset classes. Because of the tangible nature of such assets, they are seen as more of a “real” asset than other types of investments. In this regard, they contrast with assets that exist solely in financial instruments, such as derivatives, which do not exist in any physical form.
Forex, Futures, and Other Derivatives
Futures contracts, forward foreign exchange contracts, or FX spots, and an ever-expanding list of financial derivatives fall under this umbrella category of financial instruments. As the name implies, derivatives are financial products generated from or dependent on the performance of an underlying asset, such as stocks or currency.
What Is Asset Allocation?
You can begin developing your portfolio once you’ve become familiar with the various asset types. However, before choosing your investments, you need to consider what combination of assets you want to own, a process known as asset allocation.
How much cash, bonds, stocks, real estate, commodities, and/or alternatives do you want in your portfolio? There is no right or wrong answer to this question, since your investment options all come down to your career, future plans, and budget.
However, experts recommend taking the following factors into consideration before deciding on your asset allocation:
Your timeline is the first thing you need to consider when thinking about the various asset classes. How long can you commit? Long-term investment can be riskier, but it can also come with considerably higher interests and returns.
The reason is quite clear.
While markets exhibit short-term unpredictability, holding investments for several years enables you to potentially navigate and endure fluctuations effectively. On the other hand, if you’re planning to invest for a short time, you might want to reassess your risk appetite!
Your risk appetite should also affect your asset class allocation. How much risk are you prepared to take? Are you willing to risk a lot of money for the possibility of bigger returns? Answering these questions will help you determine the best investment combination for your portfolio.
What matters most is limiting probable maximum losses, regardless of your risk appetite. Diversifying your portfolio is one of the smartest ways to reduce investment risk.
Adventurous investors may be tempted by high-risk options, yet it’s vital to diversify into lower-risk financial instruments for precaution.
Read more about asset classes at Investopedia.