A group of securities that exhibit similar financial characteristics and behave the same in the marketplace is known as an asset class. Some examples of major asset classes include equities, bonds, money markets, and real estate.
Equities offer an ownership stake in a business. The familiar term for equities is stocks. Fixed-income securities, known as bonds, pay a fixed return at regular intervals over a period of time, after which the investor's principal is returned. Money market investments, which include government securities and certificates of deposit (CDs), pay a fixed interest rate and can be liquidated easily. Lastly, there is real estate. Assets classified as real estate include a person's residence, rental or investment properties, as well as commercial real estate holdings.
Why Equities Are the Riskiest Asset Class
Equities are generally considered the riskiest class of assets. Dividends aside, they offer no guarantees, and investors' money is subject to the successes and failures of private businesses in a fiercely competitive marketplace.
Equity investing involves buying stock in a private company or group of companies. Doing so extends an ownership share in those companies to the investor. When the company increases in value, stockholders' investments in the company increase in value as well. However, when the company loses value, so do the portfolios of investors heavily invested in the company. Other than dividends – fixed regular cash payments enjoyed by stockholders – equities offer no guaranteed payments or rates of return. An investor can gain 100 percent or more on an equity investment in a year, but they can also lose their entire principal. It is entirely dependent on the performance of the company.
People investing in equities must weigh the risk against the potential return. In finance, risk and return correlate positively. The more money an investor can make on a particular investment, the more that same investor stands to lose from it as well. Equities offer the potential to make a lot of money, as investors aren't shackled to a fixed rate of return, such as six percent or 10 percent.
An investor who purchases Company XYZ shares at $100 and sells them a year later for $150 makes a 50 percent return. Just as investors aren't limited by a fixed return, they aren't protected by it, either. If Company XYZ shares drop to $50 each, the investor loses half of his or her money.
How Real Estate Is Also Quite Risky
After equities, real estate subjects its investors to the most risk. The meltdown of 2008 demonstrated that real estate does not always appreciate in value. Real estate comes with additional risks not present in other asset classes. Environmental risks and maintenance costs must be weighed against potential profits when investing in real estate.
Real estate, long considered safer than equities, showed its ugly side in the late 2000s, when property values in many U.S. region. Like equities, real estate provides no guarantees. Moreover, investors must consider additional costs endemic to real estate, including maintenance costs, fees and property taxes. The roof cannot leak on stock or bond investments, but it can leak on an investment condo in Florida.
The Bottom Line
Equities and real estate generally subject investors to more risks than do bonds and money markets. They also provide the chance for better returns, requiring investors to perform a cost-benefit analysis to determine where their money is best held.