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What are Asset Classes? Types of Asset Classes

IndianMoney.com Research Team | Posted On Monday, November 18,2019, 05:48 PM

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What are Asset Classes? Types of Asset Classes

 

 

It is important to know where your money goes when you invest and how much risk it contains. Since every investment belongs to an asset class, investors need to know the most basic types of asset classes and their characteristics.

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What are Asset Classes? Types of Asset Classes

What are Asset classes?

Asset classes are a type of financial instrument that possess similar characteristics and manifests similar behavior in the market. For example, all different kind of fixed-income investments forms an asset class as they exhibit similar features.

The main reason assets are diversified into different categories is to help investors easily diversify their investment portfolios. It helps investors understand the risk factor, taxations, return rates, liquidity and market volatility associated with any asset class. Investors often rely on the diversification of asset classes to maximize their return by investing a minimal amount.

See Also: Types Of Investment Plans

Types of Asset Classes:

You can identify asset classes using several methods. An asset can be classified depending on their purpose for example, consumption assets like oil and natural gas or investment assets like shares and bonds.

There are several other ways you may categorize them for example, securities based on the markets like domestic securities, foreign or international investments.

Therefore now we are going to discuss the most popular asset classes and their unique characteristics and selling propositions.

See Also: Why Women Need to do Financial Planning?

5 asset classes:

  • Stocks/ equities: equities are part owners of a company. So when you buy the shares of a company, it gives you a percentage of ownership. Therefore you become a part of the company’s success and failures. The reason is businesses take time to expand and become successful and thus they are subjected to market fluctuation which impacts the prices of the shares.  So the profit from equities comes from the rise in the prices of the shares or dividend payment. The asset class of equities is subdivided in terms of market capitalization into small-cap, mid-cap, and large-cap stocks. It is an instrument that can help you create wealth.
  • Bonds and other fixed-income investments: these are the most popular asset classes among the Indian masses. These are the investments that give a guaranteed payment at maturity along with the invested principal. The best examples of fixed income securities are fixed deposits and public provident fund. These are instruments where the bank borrows money from you under conditions of capital protection. At maturity, you are given a maturity amount at a pre-defined rate of interest. These are mainly used to protect and grow your wealth.
  • Cash and cash equivalents: these are the money market instruments whose main characteristic feature is its liquidity. Money invested in these classes of assets can be liquidated at any time. Some examples of cash equivalents are idle money parked in your savings account or money invested in commercial papers. These generally have short maturities and thus the interest rate is lower. These instruments are used to store cash and not to generate inflation-beating returns.
  • Real estate or tangible assets: Physical assets i.e. assets owned in the form of land, commercial space, industrial space or real estate offer significant returns in the long-run and offer protection against inflation. These are generally considered to be real assets due to its tangibility. As such, these assets differ from the ones that only exist in the form of investment instruments. This is one of the most sought after asset classes in India.
  • Futures and other financial derivatives: this category of asset classes consists of futures contracts, the forex market, options and an array of financial derivatives. A derivative is a contract that derives its value by tracking an underlying that can be an asset. For example, stock options are a derivative of stocks. Other assets used as underlying are bonds, debt, foreign exchange, commodities, interest rates, and equity shares, etc.

See Also: Best Investment Plans for 2019

Diversification and Asset Classes:

For diversification of your portfolio, you don’t have to certainly know about which asset belongs to which specific category. You just need to understand the basic concept of how these investment instruments work. This fact helps you in spreading your investments across several asset classes and thus balances the risk.

The assets are often inversely correlated to each other. For example, when equities are not performing well in the share market other asset classes like bonds, real estate, and commodities may not perform well. However, during a bear market stocks, other asset classes may perform exceptionally well and give investors above-average returns.

By diversifying you can safeguard your investments in one asset class by reducing their risk exposure. The risk factor associated with your investments can also be balanced by dividing your investments among various investment profiles. This practice is known as asset allocation.

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