Understanding asset classes
There is a wide variety of investment options in the financial marketplace today, from stocks and bonds to mutual funds and exchange-traded funds (ETFs), and from real estate and commodities to cryptocurrencies. But not all these investment options are suitable for all investors, depending on the investor’s investing goals, time horizon and risk tolerance.
To help investors better understand their investing options, investment products are generally grouped by category – often referred to its “asset class”. Assets within the same asset class tend to behave similarly and are subject to similar rules and regulation.
What is an asset class?
An asset class, simply put, is a grouping of investments that share similar characteristics. There are no hard and fast rules as to what qualifies as an asset class, or how many asset classes there are, but most investment professionals consider these to be the main and most common asset classes for the majority of investors:
Cash and cash equivalents
These provide liquidity and are considered very low risk. Examples of cash or cash-based investments include money in a savings or high interest savings account, a money market mutual fund, a guaranteed investment certificate (GIC), or government treasury bills.
Fixed income/Bonds
A bond is a loan that you, the investor, make to a corporation or government. You earn interest in return for providing corporations or governments (the borrowers) the cash they need to operate.
Usually, more conservative investors use bonds to provide a steady income. A more aggressive investor could trade bonds as they might with stocks, hoping to make money by selling a bond for more than they paid for it.
Stocks
Companies sell stocks (also known as “equities” and “shares”) in order to raise money to run their business, to fund growth and expansion, or upgrade their equipment and technology. In exchange for providing the money, you, the shareholder, receive an ownership stake in the company, which includes a claim to its future earnings.
If growth is your long-term investing objective, you’ll likely want to allocate a portion of your portfolio to stocks.
Exchange-traded funds (ETFs)
An ETF is a type of investment fund - an investment product that holds a pool of different investments inside of it. What makes an ETF unique is that it is traded on a stock exchange, such as the Toronto Stock Exchange (TSX) or New York Stock Exchange (NYSE). ETF units are bought and sold daily on public markets during regular trading hours.
Mutual funds
A mutual fund is a collection of investments owned by a group of investors and managed by a professional. The investments included within a mutual fund are determined by its objectives, and can include stocks, bonds and other fixed income securities, or a mix of both.
Find out more about mutual funds.
Alternative asset classes
In addition to the more traditional asset classes noted above, there are alternative asset classes, each structured differently in how they function, how much risk they carry, and how returns are generated.
Some examples of alternative investments include:
- Commodities (e.g., gold, silver, energy or agriculture)
- Real estate
- Hedge funds
- Income trusts (e.g., real estate investment trusts)
- Foreign currencies
- Cryptocurrencies
- Derivatives (e.g., options, futures and forward contracts)
Many of these asset classes are more sophisticated in their structure, and are often geared to more experienced investors.
Why are asset classes important?
Your investments need a plan to help you reach your financial goals. Asset allocation is a relatively straightforward investment strategy that can help you to balance investing risks and rewards.
An asset allocation strategy establishes the relative proportions of asset classes – equities, fixed income, and cash-based investments – in your portfolio. Each of these asset classes have different levels of risk and different return potential, so an asset allocation strategy helps to manage risk versus reward over the long term.
The information contained in this article was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete. This material is for informational and educational purposes and it is not intended to provide specific advice including, without limitation, investment, financial, tax or similar matters.