An Introduction to Asset Classes
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The world of investing is vast, and knowing what to invest in can be overwhelming. What investment types will most effectively meet your goals? What performance characteristics do you prioritize? What is imperative to avoid?
While there are as many investment strategies as there are investors, a working knowledge of the many types of asset classes is the foundation of an investing strategy.
This article covers what asset classes are, what differentiates them from each other, and some of the most common ones so you can learn how to save and grow your wealth by investing in the right asset classes for you.
- What Are Asset Classes?
- Why Are Asset Classes Important?
- Real Assets Vs. Financial Assets
- Short Term Investments Vs. Long Term Investments
- Traditional Investments Vs. Alternative Investments
- Income-producing Assets Vs. Appreciating Assets
- What Are Some Major Asset Classes?
What Are Asset Classes?
Put simply, asset classes are categories of investable items. They are groupings of investments based on shared characteristics and market behavior. Examples of common asset classes include stocks, bonds, cash, and real estate.
Investments within the same asset class tend to share similar:
- return profiles,
- market performance,
- risk levels,
- ownership structures,
- exchange methods,
- laws and regulations, and
- taxation rates.
On the other hand, investments within different asset classes tend not to correlate with each other and differ in risk and return characteristics. They’re also usually traded within different marketplaces.
Why Are Asset Classes Important?
Asset classes help investors build their investment portfolios (i.e., their total collection of investments) in a way that meets their goals. Whether the goal is wealth preservation, growth, or income, the right mix of asset classes can make that outcome more likely.
Asset class divisions also help investors diversify, or invest in multiple kinds of assets that behave differently from one another.
This technique is believed to make your portfolio stronger as a whole. Having multiple asset classes represented in your portfolio increases its resilience and likelihood to perform according to your goals through economic changes.
Asset classes are perhaps best thought about on the basis of their distinctions. Investors and financial advisers have developed a series of different ways to categorize asset classes in order to reap the benefits of their different qualities and performance.
Note that few, if any, of these divisions are hard and fast. Some assets may touch multiple asset classes, exhibiting some of the qualities of each. A particular asset class’s performance may change over time, across regions, or in response to other conditions.
Real Assets Vs. Financial Assets
What Are Real Assets?
Real assets are tangible resources you can own and invest in, such as land or commodities. They provide value in some physical way, providing the space and materials for work and life. Thus, they are central to basic economic function on both the large and small scales.
Real assets have value in themselves and are generally more stable in value than many other asset classes. For this reason, they’re appealing to investors as an inflation hedge.
Conversely, real assets can be far less liquid, meaning they can be difficult to sell. Investors seek out real assets because they tend not to correlate with common financial assets like stocks and bonds, and in fact often move in opposite directions. That is, when stocks are falling in value, real assets often rise.
The category of real assets includes:
- real estate like farmland, apartment buildings, offices, and residential properties;
- infrastructure like bridges, roads, railways, airports, electrical lines, and cellular towers;
- resources like coal, natural gas, and timber; and
- commodities like corn, cotton, steel, and oil.
Real assets may also include precious metals and equipment.
As you learn more about investing, you’ll also encounter the terms tangible assets, physical assets, and hard assets. These concepts are all closely related and generally refer to resources that exist as concrete objects in the world. However, “real assets” is the term most applicable to goods traded for the purpose of investment.
What Are Financial Assets?
Much of what you think about when you hear the term “investment” refers to financial assets, as this category includes stocks and bonds.
Financial assets are non-physical instruments of agreement on a legal right to ownership. They rely on a contractual claim to future repayment of some kind. They don’t hold value intrinsically but rather represent value and can be recorded on paper or digitally.
Financial assets are typically liquid, meaning they can be sold and converted to cash quickly. Their value depends largely on market conditions like supply and demand.
Examples of financial assets include:
- certificates of deposit (CDs),
- debts receivable, and
Insurance is sometimes also considered a financial asset.
Short Term Investments Vs. Long Term Investments
What Are Short Term Investments?
Also known as temporary investments or marketable securities, short term investments are highly liquid investments that mature quickly.
They’re typically held for less than a year, although that window may lengthen to five years or shorten to one day depending on the asset and the investment strategy. Short term assets are defined primarily by their ability to be sold or converted to cash in a short period of time.
You may see short term investments referred to as “high quality” investment vehicles. That’s because they are common and reliable financial instruments like savings accounts and government treasury bills. Short term investments are generally financial assets, as opposed to real assets, and money moves in and out of them quickly every day.
Short term investments aren’t known to offer high rates of return, but their high liquidity makes them appealing for investors looking to generate at least some return on their cash reserves. That’s why many people opt to keep their savings in a high-yield savings account or money market account.
Investments that are often considered short term include:
- high-yield savings accounts,
- money market accounts or funds,
- some government bonds, and
- some stocks.
What Are Long Term Investments?
Long term investments are those held for a longer period of time, typically more than a year, though many have investment horizons of 10, 15, or even 20 years. This is known as a buy-and-hold strategy, which means you only dispose of the investment after it has grown in value meaningfully. Long term investments are by nature relatively illiquid.
For the individual investor, the goal of long term investing is often to achieve growth over time without having to pay constant attention to investment accounts. Because long term investments entail fewer transactions, fees are less of an expense, and depending on the investment, they may be able to produce income.
They may present the potential for higher returns, but they also entail higher risk. Long term investments may be expected to appreciate in value, as is the case in some real estate investments, but depending on market conditions, they could instead lose value. Additionally, long term investments may be subject to different taxation rates, such as capital gains tax.
Some examples of long term investments are:
- mutual funds,
- exchange-traded funds (ETFs),
- real estate,
- growth stocks, and
- high dividend stocks.
Traditional Investments Vs. Alternative Investments
What Are Traditional Investments?
Traditional investments are those that probably come to mind first when you hear the word “investing.”
Well known and widely available, traditional assets are financial instruments exclusively. Many financial advisers consider traditional investments the foundation of a portfolio, and in fact, many investors include only traditional investments in their portfolios. They’re typically relatively liquid.
The three primary traditional investments are:
- bonds, and
- cash or cash equivalents.
Because it is common and familiar to many, real estate is occasionally considered a traditional investment as well.
What Are Alternative Investments?
Alternative investments are those that lie outside the traditional categories of stocks, bonds, and cash. Alternatives aren’t necessarily newer or more rare than traditional investments; they are simply alternatives to the standard options.
Alternatives are often private, and thus subject to less regulation around the information the issuer must provide to investors. For this reason, they may be limited to accredited investors. However, there are options like certain ETFs and crowdfunding that provide vehicles for non-accredited investors to gain access to alternative assets.
One of the major appeals of alternatives is diversification. Alternative investments are often uncorrelated with the stock market or other types of assets, so they’re seen as a portfolio stabilizer. Investors also seek alternatives for potential higher returns, but they may carry more risk.
Examples of alternative investments include:
- collectibles like art, wine, and books;
- private equity;
- hedge funds;
- venture capital funds; and
Even precious metals like gold as well as real estate are frequently considered alternative assets simply because they lie outside the traditional realm of stocks, bonds, and cash.
Income-producing Assets Vs. Appreciating Assets
What Are Income-producing Assets?
Income-producing assets are exactly what they sound like: investments that return a steady stream of income in the form of dividends, interest, rent, or other consistent cash flow.
Some investors focus a portion of their portfolio on income-producing assets, while others design their entire portfolio with this in mind. Investors generally choose income-producing assets for their ability to provide a consistent profit, even if it’s a modest one, with reduced risk and volatility.
You may also hear the related term fixed income investments. This refers to some of the most stable types of income-producing assets that provide a reliable, regular return, like bonds. (In fact, “fixed-income assets” often refers exclusively to bonds.)
Examples of income-producing assets include:
- dividend stocks,
- dividend ETFs,
- real estate,
- money market funds and accounts, and
What Are Appreciating Assets?
Appreciating assets are those that increase in value over time. Appreciating assets may or may not pay out a regular return, but the growth in the value of the asset is realized when it is sold.
In order to be considered appreciating, the rate of appreciation should outpace inflation; otherwise, the asset depreciates. Shifts in value can happen for many different reasons. Any changes, positive or negative, only return to the investor once the asset is sold.
Appreciation is part of the goal for most assets: that they’ll be worth more at the time you wish to sell them than they were when you bought them. While appreciating assets isn’t a very specific category, many investors choose investments specifically for their appreciation potential in order to build greater returns over time (as opposed to focusing on generating regular income). For this reason, appreciating assets generally have a longer hold period.
Some examples of assets investors choose for their appreciation potential are:
- real estate, and
- art and other collectibles.
What Are Some Major Asset Classes?
You’ll find different opinions as to how many major asset classes there are. Some sources consider only the traditional stocks, bonds, and cash as primary. Others add real estate, while still others call some alternatives primary asset classes because of their prominence in many investing strategies.
It’s easy to get very granular when thinking about asset classes and the divisions between them. The main idea for an investor is to invest in a good mix in order to keep your portfolio diversified, balanced, and performing optimally.
This asset class is probably what comes to mind first when you think of investing. Equities are shares of ownership in a company that is publicly traded on a stock exchange. Highly regulated by the Securities and Exchange Commission, equities can typically be bought and sold by anyone.
There are many different types of stocks, all of which perform differently: growth stocks, value stocks, large-, mid-, small-cap stocks, and more.
A note on vocabulary: You’ll often hear equities used interchangeably with stocks. While there are other types of equities, the term generally refers to public equity, or company stocks as we know them. These are also called shareholders’ equity because when you invest in them, you become a shareholder, or partial owner, of the company whose stock you’ve bought.
Equity is a more general term denoting owned assets minus debts and other liabilities. Private equity refers to ownership in private companies or funds and is generally thought of as an alternative investment.
Bonds are financial assets that represent units of debt issued by governments and corporations to raise money. Bonds have a maturity date, which is the date at which the principal will be paid back. During the life of the bond, the issuer pays a regular interest rate (known as the coupon). For this reason bonds are known as fixed income assets.
Bonds tend to carry lower risk and provide lower returns than stocks. Investors choose bonds for the stabilizing effect they can have on an investment portfolio as well as to generate consistent income, for instance in retirement. Bonds may fluctuate in value over time, often in response to positive or negative performance of the company or project they were issued to fund.
Bonds are usually purchased through brokers, although U.S. Treasury bonds can be bought directly from the U.S. government. There is also a variety of bond ETFs to meet investors’ particular needs.
Cash investments are short term investments that produce interest. Low risk and low return, they are among the most secure investments, second only to a bank account. Some cash investments may even be insured by the Federal Deposit Insurance Corporation (FDIC).
Investors treat these types of investments as a place to hold cash that they may need to access quickly so that it will build gradually in value at least a little rather than depreciate due to inflation.
Common cash investments include:
- money market accounts and mutual funds,
- high-yield savings accounts, and
- short term bond funds.
Real estate is real property purchased for investment purposes. Real estate can be:
- residential, i.e., single-family homes, apartment buildings, and vacation rentals;
- commercial, i.e., office and retail space;
- industrial, i.e., warehouses and manufacturing facilities; or
- agricultural, i.e., farmland, timberland, and orchards.
Real estate can generate regular income through rent, and in favorable conditions, can appreciate in value. As a real asset, it’s also often seen as a strong inflation hedge. However, unless you contract a property manager, you take on the responsibility of being a landlord.
There are many ways to invest in real estate. One is to purchase individual properties on your own. Others include REITs and other types of real estate funds as well as crowdfunding.
Gold is arguably the oldest “investment” of all. It’s a real, appreciating asset that holds value across global markets and has performed consistently over time.
Because gold has historically been seen as the best store of value available, gold prices tend to increase when other investments fall. Investors choose gold and other precious metals for portfolio diversification and hedging against risks like inflation and political upheaval.
Silver, platinum, and palladium are other precious metals commonly invested in for similar reasons, though these tend to be far less stable in value than gold.
Investors interested in precious metals can purchase physical metals in the form of bullion, coins, or jewelry. (Depending on the form, storage may need to be taken into consideration.) Other options include ETFs and mutual funds, mining company stocks, gold certificates, and futures.
Commodities are raw goods that can be bought and sold. They are generally fungible, meaning they can be interchanged with other goods of the same type. Commodities are often thought of as the raw materials on which economic goods and services are based.
There are several different types of commodities:
- agricultural, e.g., corn, wheat, and coffee;
- meat and livestock;
- metals, e.g., iron and copper; and
- energy, e.g., oil, natural gas, and gasoline.
Considered an alternative investment, commodities often move opposite the stock market, so they can provide investors with a hedge against volatility. On the other hand, there may be other kinds of volatility within individual commodity markets due to weather or geopolitical risk.
Commodities can be invested in via company stocks, commodity-tracking ETFs or mutual funds, futures contracts, or by directly buying commodity products.
Knowing the basics of asset classes can help you stay oriented in the world of investing:
- Asset classes are often categorized based on differences in their risk, liquidity, and performance.
- There are many alternative investment options beyond the traditional stocks, bonds, and cash.
- For most asset classes, there are multiple investment vehicles to help you gain exposure in the way that best suits your needs.
When you think about your investment in terms of asset classes, you can plan for a balanced portfolio with a higher likelihood of performing according to your goals.
Explore how you can build your own real assets portfolio with land investments using AcreTrader.
This article is intended for educational purposes only; this article in no way constitutes investment advice or a recommendation to invest in any type of assets. Please note that we are not registered investment advisers. All investing contains risk.Please consult with your legal and financial advisors before investing and do not invest unless you are able to sustain the risk of loss of your entire investment.
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