What Are The Different Eggs In Your Investment Basket?
Following up on our discussion of asset allocation and diversification from last month, we wanted to address the different asset classes that are used in these processes. Investopedia defines and asset class as “a group of securities that exhibit similar characteristics, behave similarly in the marketplace, and are subject to the same laws and regulations.”
With the above definition in mind, most investment professionals would identify cash, fixed –income (bonds), equities (stocks), and alternatives (real estate, natural resources, commodities, etc) as the main high level asset classes.
ASSET CLASS DEFINITIONS[1]
Cash
“Legal tender or coins that can be used in exchange goods, debt, or services. Sometimes also including the value of assets that can be converted into cash immediately, as reported by a company.”
Fixed Income
“An investment that provides a return in the form of fixed periodic payments and the eventual return of principal at maturity. Unlike a variable-income security, where payments change based on some underlying measure such as short-term interest rates, the payments of a fixed-income security are known in advance.”
Equities
“A stock or any other security representing an ownership interest.”
Equities are often identified as Domestic or International. These are sub asset classes as mentioned below. Most portfolios that invest in equities maintain a mix of Domestic (United States) and International equities.
Real Estate
“Property comprised of land and the buildings on it as well as the natural resources of the land including uncultivated flora and fauna, farmed crops and livestock, water and minerals. Although media often refers to the “real estate market” from the perspective of residential living, real estate can be grouped into three broad categories based on its use: residential, commercial and industrial.”
Commodities
“A basic good used in commerce that is interchangeable with other commodities of the same type. Commodities are most often used as inputs in the production of other goods or services.”
As you know, we build your portfolios from a mix of the above asset classes. In fact we gather more diversification by further investing in “sub asset classes” which are more focused areas within each of the main asset classes. For instance, an equity investment may be broken down into a specific sub asset class as defined by the size of company that is being invested in or whether the company is a growth or value company. This holds for fixed income as well, where we may focus on bonds that are issued by the government or companies.
There are many sub asset classes to consider and diversifying your money amongst these different sub asset classes is one of the tools that we use towards our goal of maximizing your return for your individual risk tolerance. Hopefully this article gives you a better understanding of what makes up your portfolio.
Next month we will look at the performance of your portfolio and how to be a truly knowledgeable investor when it comes to analyzing performance.
