Use All Four Asset Classes to Build your Portfolio
You might have heard the term “asset class” used in the financial media or when you're talking with other investors, and if you're new to the game, you may have wondered what it means—or, more specifically, how different asset classes impact your odds of making or losing money.
In the simplest terms, stocks, for example, are lumped into categories with other stocks that share similar characteristics, and this is designated as an asset class. These securities might all react in a consistent way to certain influences in the marketplace, and they're generally regulated the same or in a similar fashion.
Financial professionals generally agree that there are four broad classes of assets, although some claim there are only three while others feel there are as many as five classes of assets. Regardless of the number, if your portfolio includes investments spread across various asset classes, it's considered balanced. Balance is good because it attempts to reduce risk while maximizing return.
If your portfolio is particularly heavy in one sector and that sector underperforms for some reason, you're in trouble. If your portfolio is spread out relatively evenly and just one asset class experiences difficulties, you should still have the others performing adequately enough to pull you through the crisis.
Four Classes of Assets
The four main classes of assets are generally considered to be:
These are the assets you can use to build an investment portfolio. You might notice that all stocks are lumped together even though individual stocks—or mutual funds for that matter—can be quite different. For example, a small-cap stock is not going to act the same way as General Electric.
The assets are categorized together because they will, as a group, react to financial events more alike than different. They'll respond differently from any of the other three classes, and the same thing is true for those other three classes.
Buying in All Asset Classes Matters
It might seem like splitting hairs, but the purpose of having all four asset classes represented in your portfolio is not only to prevent investment disaster but to take advantage of the different strengths of each class. The whole theory of asset allocation is based on diversifying your portfolio by asset class. For example, many people use real estate investment trusts and other more liquid investments to satisfy the real estate component of an asset class.
A portfolio that contains only one or two asset classes is not diversified and may not be prepared to take advantage of all the swings the market can throw at you. But diversification—or at least the degree to which you diversify—is also an individual decision that depends to some extent on your goals and your tolerance for risk.
If you're particularly risk-averse, you might want to diversify even more or make sure you're further diversified within each class, allowing for minor differences within that class. If you have nerves of steel and you're lucky enough to have money to burn, you might not want to rely on diversification quite as much but ride the trends of the market instead.
Always consult with a financial professional for the most up-to-date information and trends. This article is not investment advice and it is not intended as investment advice.