Assets Class 101

When developing an investment strategy for your portfolio, you have a lot of decisions to make. One of the first of these decisions is what mix of asset classes you prefer, based on your individual needs and preferences.

What Is an Asset Class?

Broadly speaking, an asset class is a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations.

Financial professionals typically suggest investors hold a mix of investments from three main asset classes: equities, bonds and cash. One reason for this suggestion is because equities tend to outperform in periods of strong economic growth, while bonds tend to outperform when growth is weaker. Many financial professionals suggest setting aside enough cash—which includes highly liquid cash-based investments such as money market funds or interest-bearing bank accounts—to cover your day-to-day living expenses for 3-6 months in case of an unexpected event.

To understand these differences better, some of the pros and cons of these three asset classes are below.

  • Cash is considered the safest option to preserve your investment and is typically the most liquid in case you need your money back quickly. However, cash offers no protection from inflation, and returns over longer periods tend to be lower than other asset classes.

  • Bonds tend to offer better returns than cash in the long run because the interest bondholders typically earn is higher than the rates paid on savings or money market funds. However, there is the possibility that bondholders will lose a portion of their investment, fail to earn a return that beats inflation or both.

  • Equities have the potential to beat inflation, especially over longer periods. However, in the short run, stock prices can fluctuate widely, which can lead to significant losses if you sell your investments at the wrong time.

Bottom Line

Typically, no single asset class meets all the needs of an investor—from easy liquidity and safety to the possibility of wealth creation over the long term.

Ultimately, the objective of a good asset allocation plan is to develop an investment portfolio that will help you reach your financial objectives with the degree of risk you find comfortable. A well-diversified plan may not necessarily outperform the top asset class in any given year, but over time, it may be one of the most effective ways to realize your long-term goals.

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