An asset class is a group or category of investments that have similar characteristics and exhibit similar behaviors. Investments in each asset class are governed by the same rules and regulations. Common asset classes include stocks, bonds and cash.
In simple terms, an asset class is a group of similar financial securities, such as stocks or bonds. Each type of asset comes with a unique liquidity profile, level of risk, and return type and potential. (For example, dividends, interest or rent income.)
The three most common asset classes include stocks, bonds, cash, and cash equivalents like CDs and Treasuries. You can also invest in alternative assets to diversify your portfolio. Common alternative investments include real estate, commodities, cryptocurrency and financial derivatives like options.
Often, different asset classes behave in differing ways and are less correlated than assets within a specific class . That means, when one asset in a certain class goes up, another in a different class may go down or grow more slowly—if it’s directly or indirectly affected at all. By contrast, assets within the same class tend to have higher correlation.
This varying behavior helps to add diversification benefits to your portfolio.
Among the most common asset classes, stocks have historically provided the highest returns. However, they’re more volatile and risky with greater likelihood of losses. By contrast, cash and similarly liquid securities, like Treasuries and CDs, are considered some of the safest investments. That said, they also tend to lose value to inflation over time.
Each type of alternative asset comes with its own risk and return profile. Real estate, for example, generally holds value better than stocks, but can also respond sharply to market pressures, and political and economic influences. Meanwhile, commodity prices rise and fall with supply and demand pressures and even natural disasters.
You can invest in a mix of asset classes to diversify your portfolio, reduce volatility and better manage risk. Each asset class offers a different level of return for the risk you take. Additionally, non-correlated assets respond differently to market stimuli offering diversification benefits.
By spreading your capital among various assets, you can reduce the chance of loss when part of the market stumbles. You can also further reduce risk by investing in multiple sectors, industries or market caps within a single asset class.
Knowing how each asset class behaves can help you make smarter investment decisions and better manage your portfolio risk. It’s wise to diversify your capital across several types of assets to capture returns (and minimize losses) in variable market conditions.
Additionally, as you age closer to retirement, you may want to move money from more volatile assets like stocks into more conservative assets, such as bonds. But, even if you’re just starting out and not thinking about retirement yet, rest assured that well-diversified portfolios tend to outperform those not-so-diversified ones.
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