Understanding investment asset classes

Put simply, asset classes are categories of investments that share similar characteristics. Understanding asset classes is key to ensuring an investor can build a diversified portfolio that can reflect their tolerance for risks and is more likely to meet their overall investment objectives.

While there is some debate about which class certain investment assets belong to, we detail some of the most common asset classes below.

Equities

Purchasing equities (also known as stocks or shares) allows an investor to buy into a fraction of a company’s value, thereby becoming a shareholder of that company. The variety of potential companies to invest in offers a broad range of risks and potential returns. However, historically, equities have exhibited considerable volatility, with the potential for higher returns.

Fixed income

Fixed-income investments such as bonds are essentially loans provided by an investor to a borrower, often governments or corporations. These ‘loans’ pay back the original investment with interest over a set period of time. Fixed-income investments are often favoured by investors seeking lower risk and more predictable returns.

Cash and cash equivalents

Cash and cash equivalents include money market funds, certificates of deposit (CDs), and Treasury bills. This asset class is considered more stable, with a lower risk of fluctuation in value compared to other investments. High liquidity means that investments in this asset class may allow investors to convert their assets to cash more quickly.

Real estate

Real estate investments include residential, commercial and industrial properties. This asset class is often regarded as lower risk than investments such as equities given that property values and rental income typically stay in line with inflation. There also tends to be lower correlation between the performance of real estate and other asset classes, offering potential diversification benefits.

Commodities

Commodities are goods and natural resources such as metals, oil and agricultural products. Investment in commodities is viewed by some investors as an effective way to hedge against inflation, given the price of commodities usually goes up in line with inflation. This asset class may have a lower correlation with equities and bonds, which could also provide a good opportunity for diversification.

Alternative investments

‘Alternative investment’ is often used as a catch-all for investable assets that do not fit within traditional categories. This asset class can include private equity, hedge funds and cryptocurrency. While the variety of investments included means there is a wide range of risks and return potential, alternative investments are used by some investors to provide diversification owing to their lower correlations with more traditional asset classes.

An awareness of the various investment asset classes is essential for anyone looking to understand the basics of investing and, in particular, the importance of portfolio diversification. Each asset class offers distinct characteristics, and thoughtful portfolio construction can help to balance investment risks and returns, as well as help investors achieve their financial goals.