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An asset class is a group of securities that are fundamentally similar to each other, while being fundamentally different from other asset classes. Understanding asset classes makes investing easier.

Traditionally, there are three main asset classes: equities, which are also called stocks; fixed income, which are primarily bonds; and cash equivalents. In recent years, a fourth asset class has been added: alternative investments. This includes real estate, commodities, some hedge funds, private equity and art.

Equities are shares in the ownership of publicly owned businesses. Their value goes up and down with investors’ perceptions of the firm’s performance. Historically, this asset class provides the highest return, but is the most volatile.

Fixed income is any investment that pays the owner a fixed return each year for a set number of years, then returns the principle to the buyer. Bonds and annuities are types of fixed income. Their value is more stable than stocks, but does fluctuate in response to changes in market interest rates.

Cash equivalents include cash and short-term liquid securities such as government issued securities, CDs, banker’s acceptances, euros and commercial paper. This is the most stable asset class.

Real estate includes homes and investment properties, and funds that hold groups of them. While these tend to be more stable than stocks, their value can rise or fall sharply depending on economic conditions.

Owning investments from different asset classes, which is called diversification, is an accepted way to reduce a portfolio’s overall volatility. 

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