Defining what asset classes are may seem trivial, but it is important because these are key components of a diversified portfolio. Each asset class needs to have a specific risk- return function, the detail of which many employers and members may not fully grasp. We hope that this simplified guide will be useful.
What does an asset class mean?
An asset is a piece of property that can be sold for cash, or traded for another property of equal value. Common asset classes include:
-Fixed income (bonds)
-Cash equilivants (money market instruments) and
-Property (real estate)
Each asset class includes assests bought and sold in the same way. The assets in each class also have the same guidelines or laws governing how they are traded, bought, or sold. Generally, assets in the same asset class also experience similar results in the marketplace. For example, when a stock market is said to be down, many individuals stocks lose value.
Company shares sold on the open market or over the counter make up the stock asset class. Historically, equities have experienced more volatility than other asset classes. Due to increased risk, returns can be higher than in other classes.
Fixed interest/ Bonds
Debt instruments issued by companies, and federal and municipal governments, are included in the bond or asset class. A company issues bonds to raise money. Investors purchase the bonds and earn a fixed interest rate. Generally, bonds have less risk than equities.
Cash/ Money Market instruments
Cash equivalents or cash accounts are usually provided to investors by banks, credit unions, and investment firms- such as Money Market accounts. Investors earn interest similar to that of a savings account and, similarly, the returns may be lower compared to the other asset classes since there is much less risk involved.
Property/ Real Estate
To invest in the property asset class, buyers need to purchase real property. They can also participate in this market by purchasing investments in other asset classes. Options include buying shares in a real estate exchange traded fund (ETF) and purchasing shares in a real estate company.
Source: The Corporate Adviser (Old Mutual)- issue April 2011- 01