What is an Asset Class?
Ever looked at your portfolio and wondered what’s actually in there? There may be a few stocks, a real estate holding, maybe a bond or two. What your portfolio is made up of is a variety of investment securities that can be categorized into one or more asset classes.
An asset class refers to a type or group of investments that:
- Have similar characteristics
- Behave similarly in the marketplace
- Are subject to the same laws and regulations.
There’s lots of different types, each with their own merits. But, before we jump into what’s great about using asset classes in your portfolio, let’s quickly review the most common types.
Types of asset classes
- What is it? Owning a part of a company through stocks or shares. As the company’s value increases, so too does the stock or share value, allowing investors to benefit from the company’s growth. Equities can be further categorized by geographies or sectors—learn more about equities.
- How risky is it? Equities are considered a riskier asset class as their value can quickly go up or down. But, they offer some of the highest return potential.
- What is it? An investment security that pays investors a fixed payment until a specified maturity date. Both the maturity date and payment amount are predetermined. Common examples of fixed-income securities include government and corporate bonds, and term deposits like guaranteed investment certificates (GICs)—learn more about fixed income.
- How risky is it? Because the payment is predetermined, there is less risk associated with fixed income, but with a trade off of lower return potential.
Cash and equivalents
- What is it? Current assets on hand—think money market funds or bank savings accounts. They’re also highly liquid, so they’re easy to buy and sell quickly.
- How risky is it? There’s very little risk to the initial value of your investment with cash and some instruments offer interest at a low rate. But those lower rates mean you run the chance of losing value in the long term due to inflation.
Alternative investments are considered the non-traditional asset classes and can include a variety of sub-classes. Two primary sub-classes are real estate and commodities.
- What is it? Buying a home (for purposes other than as your primary residence) or investment properties, or investing in a Real Estate Investment Trust (REIT). A REIT acts like a mutual fund so investors can get exposure to real estate properties without having to actually buy or manage the properties themselves.
- How risky is it? Typically more stable than equities, real estate can still offer higher returns than other asset classes. However, values can fluctuate quickly.
- What is it? An exchangeable physical good or asset. Examples include gold and other metals, oil and gas, and even cryptocurrencies. Most commodities are traded through futures contracts on exchanges that have standard rules for the quality and quantity of the commodity being sold.
- How risky is it? Commodities are considered a riskier asset—but with higher growth potential—than say cash or fixed income as their value can go up or down quickly.
Asset allocation and diversification
The real magic behind asset classes isn’t just what they are, but how they’re used in your portfolio. When you invest in multiple asset classes it increases your portfolio’s diversification. The more diversification, the better protected your investments are from dips or swings in a single segment of the market.
For example, say your portfolio has a mix of equities, cash and real estate. One day, stock markets take a turn and your equity holdings drop in value. While that portion of your portfolio may see negative returns, you’ve still got money invested in cash and real estate to keep your overall portfolio out of the red.
The actual mix of asset classes in your portfolio is called asset allocation. This is where specific asset classes and their weightings are picked to provide you with a level of risk and return aligned with your goals, risk tolerance and time horizon. This can help keep your financial plan on track—providing enough return to reach your goals and a level of risk you can stomach without changing your savings habits or investment strategy.
Our investment strategy is based on the view that your asset mix is the primary driver of portfolio returns. But setting your asset allocation and building a diversified portfolio can be complex and time consuming. We use a diversified mix of asset classes in our managed portfolios to maximize returns at different levels of risk and make it easy for you to invest in a portfolio that makes sense for you. Learn more about our managed portfolios.