What Is an Asset Class?

Asset Classes Explained In Less Than 5 Minutes

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An asset class is a group of investments that have similar characteristics, are subject to the same laws and regulations, and generally respond similarly to market fluctuations. Historically, the main asset classes have been equities (stocks), fixed-income assets such as bonds, cash or cash equivalents, and tangible or real assets.

This article examines the various types of asset classes, why investors group securities in asset classes, and some new and emerging asset classes to know about.

Definition and Examples of Asset Classes

An asset class is a group of investments that have similar traits in terms of risk and growth potential, and also tend to respond similarly to market fluctuations. They are a means of grouping similar securities together, partly for investment strategy purposes. Diversification of one’s investment portfolio—an important tenet of investing—is easier to understand and carry out because asset classes exist.

The most common asset classes in investing portfolios include:

  • Cash and cash equivalents (e.g., money market funds)
  • Equities, like U.S. and foreign stock
  • Fixed-income securities
  • Real, tangible assets
  • Commodities

Most asset classes can be subdivided into more specific categories. Also, relatively new investment options have created additional asset classes, such as cryptocurrency and other digital assets.

While assets within the same asset class share common traits, some may be more volatile than others. For example, large-cap stocks are considered less volatile than small-cap stocks, even though both reside within the equities asset class.

How Asset Classes Work

Individual investors and investment advisors use asset classes to structure investment portfolios around specific investment objectives and to help with diversification within their portfolios. This is known as asset allocation

Investment vehicles within the same category share common traits, such as taxation, risk, liquidity, market volatility, and returns. Because assets within the same asset class have similar characteristics, they typically react similarly to market-moving events.

It is widely recommended that individuals spread their investment funds across several asset classes to reduce volatility and risk. If the majority of your portfolio consisted of just one asset class, and a major market-moving event occurred that would disrupt performance in that space, you could face great loss.

Similarly, when one portion of an investor’s total portfolio becomes very large due to strong performance, the stakeholder will often rebalance among the different asset classes. They do this by shedding some of the oversized holding and purchasing more from one or more of the other asset classes.

Types of Asset Classes

As mentioned, there are many asset classes that are important for individual investors to know. Below, find descriptions of some of the most common asset classes. a quick summary of the most common asset classes and their features.

  • Cash and cash equivalents: These include short-term investing vehicles such as bank accounts, money market mutual funds, and Treasury bills that keep assets liquid.
  • Fixed income: These are generally used to keep an investor’s principal safe while providing some additional returns. They also include corporate and government bonds, and corporate debt securities. 
  • Equities: Stocks in U.S. and foreign companies provide stakeholders returns in the form of increased price per share and/or dividends. As a general rule, different types of stocks have varying levels of risk and potential return.
  • Real assets: Tangible property such as real estate, art, and collectibles are real assets. They are less liquid than stocks and bonds, meaning they can be more difficult to sell on short notice. 
  • Private investments: Private assets are those that are not traded publicly, including venture capital opportunities such as investing in a startup company.
  • Cryptocurrency and other digital assets: Digital currencies are traded on the internet using blockchain technology. Other digital assets include non-fungible tokens (NFTs)

Not all types of investments fall neatly into an asset class. For example, some firms consider commodities to be a real asset since they deal with tangible goods, while others consider them an alternative investment, worthy of their own class.

What Asset Classes Mean for Individual Investors

You should always aim to create a portfolio that suits your investment objectives and risk tolerance. Most often, this means diversifying across a wide range of asset classes. Understanding what asset classes your current holdings or prospective investments fall into allows you to shape your investment portfolio around the goals and risk factors.

It is also possible to get a general sense of what returns you can expect for any given asset by examining the returns for the broader asset class. This is not a hard and fast rule, of course, as different large-cap stocks will have different returns. But generally, stocks, over the long run, have provided the highest returns of any asset class, with a correspondingly higher risk of volatility and losses over shorter durations.

Whether you are a young investor just starting to create an investment plan, or a seasoned investor with significant assets, shaping your portfolio to match your goals, risk tolerance, and time horizon is critical. Knowing the historical performance of different asset classes will help you achieve this goal.

Key Takeaways

  • An asset class is a group of investments that have similar risk and growth potential, and generally respond similarly to market fluctuations.
  • Examples of asset classes include stocks, bonds, cash and cash equivalents, and real, tangible assets.
  • Cryptocurrency and other digital assets are considered to be part of a newly developed asset class.
  • Asset classes help investors create diversified portfolios that match their investment objectives, risk tolerance, and time horizon.