What are asset classes?

Understanding how different asset classes work can help you evaluate the potential risks and rewards that come with investing.

For example, it’s common knowledge that stocks are riskier than bonds because they don’t offer guaranteed returns. Due to the nature of this risk, you may want to invest in several assets to diversify your portfolio. Diversification reduces the amount of exposure to any given asset in your portfolio (if it loses value) and reduces the overall volatility of your investment portfolio.

Let’s look at some common asset classes and the possible risks and rewards of each.

Cash and cash equivalents

Many investors hold onto a certain amount of cash so they have one liquid asset they can rely on. If an asset is liquid, it’s easily accessible and available for immediate use. Cash and cash equivalents are all low-risk investments, but they also offer low returns.

Here are some examples of cash and cash equivalents:

• Treasury bills: Treasury bills are short-term debt obligations backed by the U.S. Treasury Department. They’re usually sold in denominations of $1,000 and have a maturity of one year or less.
  
  
• Commercial papers: Commercial papers are short-term debt obligations offered by corporations. It’s a money market instrument and usually has a maturity of up to 270 days.
  
  
• Certificates of deposit (CDs): A CD is a type of savings account offered by banks and credit unions. When you open a CD, you agree to leave your money there for a certain period of time and earn a guaranteed rate of return once the term is up.
  
  
• Money market funds: A money market fund invests in short-term debt securities. Though they sound similar, it’s not the same thing as a money market account.

Equities (stocks)

Equities are often referred to as stocks, and they represent a small portion of ownership in a company. For example, if you buy one share of Rocket Companies, you own a tiny portion of our corporation.

Investing in stocks is far riskier than investing in cash and cash equivalents. However, stocks also come with the potential for much higher returns on your investment.

Fixed income (bonds)

If a government, municipality or corporation wants to raise money, they’ll offer bonds which are a type of debt security. When borrowers invest in bonds, the issuer will pay back their original investment with interest.

Mortgage-backed securities are a type of bond an investor buys from a mortgage aggregator. This investment product is a bundle of similar home loans, usually issued by Fannie Mae, Freddie Mac and Ginnie Mae. Anyone investing in mortgage-backed securities will receive regular payments while they’re holding the bond. These payments come from the monthly mortgage payments that homeowners make each month.

Bonds are also a low-risk, low-return investment, especially when compared to stocks. But unlike stocks, you’ll receive a guaranteed rate of return.

Real estate

Real estate is another asset class and can be broken down into two main types — commercial and residential properties. When you invest in residential properties, this usually involves single-family homes, condos, townhomes and vacation properties. Commercial real estate may involve buying multi-family properties, retail, office space or hotels.

The biggest benefit of real estate investing is that it provides the potential for steady cash flow and equity appreciation over time. But the housing market is unpredictable and there’s always the potential for drops in the value of property or high tenant vacancy rates.

Alterntative asset classes include things like cryptocurrency, private equity, hedge funds and more. Many people consider cryptocurrency an extremely risky investment because there’s no underlying asset behind it. Before choosing alternative investments, make sure to do your research and consider the pros and cons of that decision.

A real estate portfolio is a collection of real estate investments, like rental homes, flipped properties and real estate investment trusts (REITs). If you’re trying to figure out how to build a real estate portfolio, it’s best to start small. For the first year or so, focus on learning the basics like how to increase the property’s value.

It’s also important to understand the market you’re operating in. Are there any up-and-coming neighborhoods you might want to invest in? Once you know where you’re looking to buy, you can keep an eye out for any deals that pop up.

As you’re building your investment portfolio, it’s crucial to avoid putting all your eggs in one basket. Diversifying your assets will help mitigate your financial risk and add a layer of stability to your portfolio. If you’re not sure where to begin, you may want to consult with a financial advisor for guidance.

Here’s some additional information about how asset classes work.

Why is it important to consider different asset classes?

Learning about different asset classes will help you evaluate all your options and find the investments that are right for you. You can also work with a financial planner to help you choose different assets.

What is the riskiest asset class?

Alternative investments are the riskiest investments, but the stock market also comes with a high level of risk. With both assets, there’s no guarantee you’ll make a return on your investment.

How many asset classes should I have?

This number will be slightly different for every investor. Instead of trying to decide on a number of investments, focus on building a diversified portfolio.

Asset classes are groups of assets with similar features and regulations. Cash and cash equivalents, stocks, bonds, real estate and alternative assets are the most common types of asset classes. If you’re looking to get started in real estate investing, you can start the mortgage process today.