What are asset classes?

If you’re an investor, it’s important to understand the different types of investments available to you and the differences between each class of assets.

Put simply, an asset class is a group of investments that share similar characteristics and regulations.

Most people invest in a variety of asset classes, including stocks, bonds, and real estate, to build a diversified portfolio. If you’re getting into investing or want to learn more about the different

Asset class basics

Understanding the differences between asset classes is crucial for investors seeking to build a well-diversified investment portfolio. Each asset class has a different risk and return profile, so it’s essential to own a diversified mix of various asset types.

Different investments fall into the same asset class based on shared characteristics, such as:

• Trading in the same markets
• Being subject to the same regulations
• Being based in the same location (such as domestic vs. foreign markets)

Risk mitigation

Putting all your money into a single asset class can be incredibly risky, so diversification can help you limit that risk.

For example, imagine someone who had all their money in real estate in 2007, the year before the Great Recession. When the housing bubble burst, they’d have seen their investments fall in price by a considerable amount. Someone who had diversified into other assets, such as bonds, would not have seen such severe losses.

Types of asset classes

Rocket Mortgage can help you understand the main asset classes, as well as the risks and rewards of investing in each.

Keep in mind that asset classes are broad categories, and there can be some debate about which asset class certain investments fall into. For example, many people treat real estate as its own asset class, but some may group it with real assets, such as raw materials like oil.

Real estate

Real estate is a significant asset class with several types of investments. All real estate investments involve buying property, but these investments can be either short-term or long-term.

For example, house flippers make short-term real estate investments, while landlords take a long-term view.

Why invest in real estate? Real estate asset classes can provide both regular income and long-term value appreciation. However, the real estate market can be volatile and unpredictable, so people who invest in real estate may face losses if the market turns.

Real estate can be broken into two major categories:

• Residential. This class encompasses places where people reside, including condominiums, duplexes, and single-family homes.
• Commercial. This class includes office buildings, stores, and, in some cases, apartment buildings with five or more units.

Cash and cash equivalents

Cash and cash-equivalent assets are highly liquid, meaning you can spend them directly or quickly turn them into money you can spend.

For example, money in a savings account or money market funds would be considered cash or a cash equivalent.

Generally, these investments are considered low risk. The main risk is that inflation will reduce your purchasing power. You also will face the opportunity cost of not investing in higher-yielding assets.

However, you generally won’t earn a significant return, so it’s important to diversify into other asset classes if you want to see your wealth increase over time.

Examples of cash and cash equivalents include:

• Treasury bills. These are short-term government bonds that are easily sold on the open market.
• Savings accounts. These are bank accounts that hold cash, which can be easily spent.
• Money market funds. These funds invest in low-risk bonds and can easily be converted to cash.

Equities

Equities are an ownership stake in an asset, such as a business. The best-known equity investment is stocks, but there are other types.

Equities can offer both cash flow, in the form of dividends, and long-term value appreciation, but can be risky because they can lose value quickly.

Examples of equities include:

• Stocks. Stocks represent an ownership stake in a publicly traded company and entitle the owner to a vote for the board of directors and, if applicable, dividend payments.
• Private equity. Private equity investments are made in companies that are not public.
• Venture capital. Venture investments are made into early-stage companies. Investments are risky and illiquid but can provide high returns.

Fixed income

Fixed-income investments offer a regular source of cash flow based on the amount you paid. For example, if you buy a bond, you get a regular interest payment until the bond’s term ends.

Fixed income investments tend to be low risk, especially if you’re buying government bonds, though low-grade bonds do have default risk to keep in mind. Generally, the return you can receive increases based on the perceived risk of the investment.

Examples of fixed income investments include:

• Government bonds. These are issued by major governments and are usually among the lowest-risk investments available.
• Corporate bonds. These are debt instruments issued by companies that want to borrow money. Potential risk and return can vary based on each company’s financial profile.
• Certificates of deposit. CDs are bank accounts that offer interest payments in return for a guarantee that you’ll keep your money in the account for a set period. Early withdrawals can lead to penalties.
• Mortgage-backed securities. MBSs are fixed-income investments based on a portfolio of mortgage loans. Investors receive payments based on the mortgage payments made by the borrowers included in the MBS. However, if homeowners stop paying their mortgage, investors could lose money.

Alternative asset classes

The above asset classes are highly popular among investors and comprise a significant portion of the overall market. However, there are many other asset classes that investors can consider investing in.

Generally, alternative asset classes are viewed as a higher risk. They may not have the same level of regulation, if they’re regulated at all. However, some investors feel they offer higher potential returns.

Before investing in an alternative asset, conduct thorough research and consider consulting a financial professional to determine if it’s a good fit for your portfolio.

Some examples of alternative assets include:

• Cryptocurrency. Cryptocurrencies are digital currencies that can be traded and sometimes used to buy or sell goods and services. Values can be highly volatile.
• Hedge funds. Hedge funds aim to outperform the market’s overall return by investing in specific companies or attempting to time the market. Unlike mutual funds, which are usually open to the public and often follow a published strategy, hedge funds are private and have strategies that may not be publicly disclosed. Management fees can be high.
• Crowdfunding. Some companies choose to raise money by soliciting investments from many individuals rather than large investment businesses. You may receive an ownership stake or promise of future payments, but if the company fails, you’ll lose your investment.

FAQ

Understanding the various asset classes and how they fit into your portfolio is essential for achieving success as an investor.

Why is it important to consider different asset classes?

Each asset class has its own risk and returns profile. You should consider different asset classes to build a portfolio that matches your personal appetite for risk. For example, you might mix stocks and bonds to make a portfolio that will appreciate over time without being as volatile as a portfolio that goes all-in on equities.

What is the riskiest asset class?

Alternative investments are considered the riskiest asset class due to their high rate of loss and limited regulation. Among the traditional asset classes, equities are usually considered to be the riskiest but typically have the highest potential returns.

How many asset classes should I have?

There’s no one answer to the number of asset classes you should invest in. It’s all about building a portfolio that aligns with your risk tolerance and desired returns. Many people build a portfolio composed of stocks and bonds and get exposure to real estate by owning a home. Still, you should consult a financial advisor for help building the right portfolio for you.

The bottom line on asset classes

Every asset class is unique, generating distinct levels of cash flow and asset appreciation, and carrying varying levels of risk. Understanding how asset classes differ will help you plan your investment portfolio effectively. Before you start investing, consider consulting a financial advisor for guidance on determining the best approach for building your portfolio.

If buying a home or an investment property is part of that plan, apply for a mortgage with Rocket Mortgage^® today.