Asset classes can be seen as a collection of financial products with common characteristics like risk, returns, liquidity, and various other parameters. Having different assets in your portfolio allows you to take advantage of the different strengths of each class. While all assets have their pros and cons, a basic knowledge of these assets will help you understand how to invest better.
Assets put money in your pocket. The more assets you have making money for you, the richer you get. If you have an investment portfolio or intend to build one, these are 5 asset classes you should consider:
1. Cash
They include liquid funds, saving accounts, online wallets, hard cash, money market instruments and certificates of deposit (CDs). Cash provides a safe haven for funds when markets are rocky or looking overvalued. It offers liquidity and most cash deals offer higher returns(Peer to peer lending).
They are an important part of an investment portfolio because their high liquidity makes it easy for you to readily seize opportunities. Unlike stocks and other assets, cash equivalents must have a determined market price that doesn’t fluctuate. The downside of cash and its equivalents is, interest from banks doesn’t keep up with inflation.
2. Stocks
Stocks are a collection of shares (units of ownership of a company). The company divides its capital into equal parts, which it can then sell as shares.
Owning stocks in different companies can help you build your portfolio, protect your money from inflation, and maximize income from your investments if you consider a long-term perspective. The downside just like any investment is it comes with risks. The stock market is volatile and best suited to long-term investing.
3. Bonds
Bonds are a debt instrument or an IOU. They contribute an element of stability to any diversified portfolio. Bonds are a safe and conservative investment that offers relatively low volatility, high liquidity and a measure of legal protection.
When you invest in bonds, you lend money to the bond issuer (corporations, local/ federal Governments). You lend them the money for a specified period of time known as the bond term. They in turn pay you interest at a specified interest rate. The downside is a lower rate of return.
4. Real estate
Real estate is the most common type of tangible assets that people own. It offers passive income and long-term wealth.
You can create regular income and cash flow, protect against inflation and build equity for the future with real estate investment opportunities(REIT’s – Real Estate Investment Trusts, rental properties – residential, commercial, industrial, retail e.t.c). The major drawback is it requires a lot of upfront capital and you lose liquidity.
5. Commodities
Commodities offer an inflation hedge unmatched by other asset classes and the prospect of improved risk-adjusted returns. It benefits investors during economic uncertainties.
They are riskier forms of investments with opportunities to make huge profits. Another downside of commodities is that they are susceptible to weather and regulatory risks. Commodities can be divided into four sectors;
1. Agriculture – livestock, wheat, corn
2. Energy – natural gas, coal, crude oil
3. Industrial metals – Steel
4. Precious metals – Gold, Silver
FINAL THOUGHTS
Your portfolio is considered balanced when it includes investments spread across various assets. Diversifying your portfolio is ideal because it helps to reduce risk while maximizing returns. Assets all have their advantages and disadvantages. Consider your risk tolerance and financial goals before opting for any investment option.
“Diversification is protection against ignorance,”
-Warren Buffet