What Is an Asset Class?

An asset class is a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations. Asset classes are thus made up of instruments that often behave similarly to one another in the marketplace.

Key Takeaways

  • An asset class is a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations.
  • Equities (e.g., stocks), fixed income (e.g., bonds), cash and cash equivalents, real estate, commodities, and currencies are common examples of asset classes.
  • There is usually very little correlation and in some cases a negative correlation, between different asset classes.
  • Financial advisors focus on asset class as a way to help investors diversify their portfolios.
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Asset Class

Understanding Asset Classes

Simply put, an asset class is a grouping of comparable financial securities. For example, IBM, MSFT, AAPL are a grouping of stocks. Asset classes and asset class categories are often mixed together. There is usually very little correlation and in some cases a negative correlation, between different asset classes. This characteristic is integral to the field of investing.

Historically, the three main asset classes have been equities (stocks), fixed income (bonds), and cash equivalent or money market instruments. Currently, most investment professionals include real estatecommodities, futures, other financial derivatives, and even cryptocurrencies to the asset class mix. Investment assets include both tangible and intangible instruments which investors buy and sell for the purposes of generating additional income, on either a short- or a long-term basis.

Financial advisors view investment vehicles as asset class categories that are used for diversification purposes. Each asset class is expected to reflect different risk and return investment characteristics and perform differently in any given market environment. Investors interested in maximizing return often do so by reducing portfolio risk through asset class diversification.

Financial advisors will help investors diversify their portfolios by combing assets from different asset classes that have different cash flows streams and varying degrees of risk. Investing in several different asset classes ensures a certain amount of diversity in investment selections. Diversification reduces risk and increases your probability of making a return.

Asset Class and Investing Strategy

Investors looking for alpha employ investment strategies focused on achieving alpha returns. Investment strategies can be tied to growth, value, income or a variety of other factors that help to identify and categorize investment options according to a specific set of criteria. Some analysts link criteria to performance and/or valuation metrics such as earnings-per-share growth (EPS) or the price-to-earnings (P/E) ratio. Other analysts are less concerned with performance and more concerned with the asset type or class. An investment in a particular asset class is an investment in an asset that exhibits a certain set of characteristics. As a result, investments in the same asset class tend to have similar cash flows.

Asset Class Types

Equities (stocks), bonds (fixed-income securities), cash or marketable securities, and commodities are the most liquid asset classes and, therefore, the most quoted asset classes.

There are also alternative asset classes, such as real estate, and valuable inventory, such as artwork, stamps, and other tradable collectibles. Some analysts also refer to an investment in hedge funds, venture capital, crowdsourcing, or cryptocurrencies as examples of alternative investments. That said, an asset's illiquidity does not speak to its return potential; It only means it may take more time to find a buyer to convert the asset to cash.

What Are the Most Popular Asset Classes?

Historically, the three main asset classes have been equities (stocks), fixed income (bonds), and cash equivalent or money market instruments. Currently, most investment professionals include real estate, commodities, futures, other financial derivatives, and even cryptocurrencies to the asset class mix.

Which Asset Class Has the Best Historical Returns?

The stock market has proven to produce the highest returns over extended periods of time. Since 1920 the CAGR (compounded annual growth rate) for the S&P 500 is about 7.63%, assuming that all dividends were reinvested and adjusting for inflation. In other words, one hundred dollars invested in the S&P 500 on January 1, 1920, would have been worth about $167,983 (in 1920 dollars) by December 31, 2020. Without adjusting for inflation the annual rate of return would be 10.46% and the total would have grown to a whopping $2.3 million. By comparison, the same $100 invested in 10-year Treasuries would have been worth only a little more than $8,000.

Why Are Asset Classes Useful?

Financial advisors focus on asset class as a way to help investors diversify their portfolios to maximize returns. Investing in several different asset classes ensures a certain amount of diversity in investment selections. Each asset class is expected to reflect different risk and return investment characteristics and perform differently in any given market environment.