The term 'Asset Classes' is included in the Economics edition of the Financial Dictionary. Get your copy on Amazon in Kindle, Paperback or Audio edition. Check for lowest price here...
Asset classes are different groups of securities which demonstrate characteristics in common, are governed by similar regulations and laws, and behave similarly in the markets. There are five principle classes which include equities (stocks), fixed income (bonds), money market instruments (cash equivalent), commodities (like gold and oil), and real estate (including land, houses, and commercial buildings), as well as some other less common alternative classes of assets.
Many times these different classes of assets are intermingled by financial advisors and analysts. They like these different types of investment vehicles to diversify portfolios more effectively and efficiently. Every asset class is anticipated to provide differing levels and types of risks versus returns among its investment characteristics. They also are supposed to perform differently in any given investment climate. Those investors who seek out the highest possible returns typically do this by lowering their overall portfolio risk by performing diversification of asset classes.
Financial professionals typically focus their clients on the different asset classes as a means of steering them into proper and effective diversification of their investment or retirement portfolios. The various classes of assets possess differing amounts and types of risk as well as varying cash flows. By purchasing into several of the competing asset classes, investors make certain they obtain a proper level of diversification in their investment choices. The importance of diversification can not be overstated. This is because all financial professionals in the know understand that it lowers risk while maximizing the opportunities to earn the highest possible return.
There are a variety of different types of investment strategies available to investors today. They might be associated with value, growth, income, or a combination of some or all of these factors. Each of them works to categorize and label the various investment options per a particular grouping of investment criteria.
There are many analysts who prefer to tie traditional valuation metrics like price to earnings ratios (PE ratios) or growth in earnings per share (EPS) to the investment selection criteria. Still different analysts feel like performance is less of a priority while asset type and allocation are more critical. They know that investments which are in the identical class of assets will possess similar cash flows, returns, and risks.
The most liquid of these various asset classes prove to be equities, fixed income securities, cash- like instruments, and commodities. This also makes them the most frequently quoted, traded, and recommended classes of assets available today. Other asset classes are considered to be more alternative such as real estate, stamps, coins, and artwork, all of which are tradable forms of collectibles. There are also investment choices such as venture capital funds, crowd sourcing, hedge funds, and bitcoin, which are considered to be even more alternative and mostly for sophisticated investors. In general, the rule is that the more alternative the investment turns out to be, the less liquidity it actually possesses.
Some of these investments, such as hedge funds, venture capital funds, and crowd sourcing can take years to exit from, if investors are able to withdraw from the investment at all. Lower liquidity does not necessarily correlate to lower return potential though. It only means that it may be a while before holders are able to find a willing buyer to sell the investments to so they can cash out of the investment.
Many of the most alternative types of investments have boasted among the highest returns over the decades, sometimes significantly better returns than the most popular two asset classes of stocks and bonds. In order to get around this lack of liquidity and often enormous investment capital requirement, many investors choose to utilize REITS. Real Estate Investment Trusts provide greater liquidity while still participating in price appreciation of the real estate asset class.