Use all Four Asset Classes to Build your Portfolio
You might have heard the term “asset class” tossed about by the media or when you're talking with other investors, and if you're new to the game, you probably wondered what it means. Specifically, how does it impact your odds of making or losing money?
In simplest terms, securities are lumped together with others that share similar characteristics and this is an asset class. These securities might all react much the same way to 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 many claims there are only three and some feel there are as many as five. Regardless of the number, if your portfolio includes investments spread across these classes, it's considered balanced. Balance is good. If your portfolio is particularly heavy in one sector and that sector tanks 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 classes of assets are generally considered to be:
These are what you need to have available to build a 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.
They categorized together because they will, as a group, react 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.
Yes, it might seem a bit 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 leg of the asset class tool.
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.