What Are Asset Classes: Your Quick Start Guide

When you start investing, one of the first concepts you’ll run into is diversification. Rightly so! A diversified portfolio can help your investments survive the ups and downs of the market. 

That starts with choosing a smart balance for your asset classes. 

By the end of this post, you’ll have a clear understanding of asset classes, why they matter, and how to use them to build a diversified portfolio. (It’s easier than you think.) 

What are asset classes?

You can think of an asset class as a way to categorize your investments. Each category is defined by certain characteristics that are shared by all the assets in that category. This may include their:

• Structure
• Governing laws and regulations
• Trading market
• Response to economic events

In other words, asset classes are groups of similar (but not identical) investments. Examples include stocks, bonds, real estate, and even cash accounts.  

Why do asset classes matter?

Each asset class is unique. Knowing an investment’s asset class can provide clues about its potential risks, rewards, and behavior. 

You can use this knowledge to diversify your portfolio. 

For instance, many asset classes respond differently to the same market conditions. Mixing and matching asset classes spreads your dollars around to help protect against asset-specific downturns. 

When an investment from one asset class drops in value, an investment from a different class may be more likely to rise, so your portfolio as a whole doesn’t suffer so much. That’s the heart of diversification — making it stronger by spreading your eggs around instead of putting them all in one basket.

What are the different asset classes? The Big Three

Historically, investors have relied on the “big three” asset classes. We’ll explore some alternatives later.

Cash and cash equivalents

Cash and equivalents include cash and assets that easily convert into cash, like:

• High-yield savings accounts
• Money market funds
• Treasury bills
• Short-term certificates of deposit (CDs)

This asset class is known for being generally safer than other classes. In fact, they’re considered safe enough that investors often use them to store and grow their emergency funds. 

However, because they’re so safe, they typically yield lower returns than other kinds of investments.  

Bonds

Bonds are fixed-income investments known for making regular income payments to the people who invest in them. You lend money to the bond issuer, and in return, you receive interest payments until the bond matures. (Usually.) At maturity, you receive your original loan amount back. 

Governments and corporations often issue bonds. Generally, bonds from stable governments pay the least interest. Bonds issued by companies and governments of developing economies may pose more risk, and so pay higher yields. (But still may underperform stocks.) 

Stocks

Stocks represent tiny slices of ownership in the company that issues them. Companies sell stocks to raise money, after which, the stocks trade on exchanges like the NYSE or NASDAQ. Investors make money on stocks by collecting dividends (if the stock pays out) or selling their shares for more than they paid. 

Stocks tend to be riskier than cash and bonds. For one, there’s no guarantee that the company will hold its value or even stay in business. Stock values may also drop based on bad economic, political, or regulatory news. 

Alternative asset classes

“Alternative assets” is the umbrella term for any investment that’s not stocks, bonds, or cash. These assets tend to have unique structures, regulations, and tax implications. They may also be more volatile or unpredictable. We’ll cover a few common ones below. 

(Note that there are many others — hedge funds, venture capital, and art, for example, are also considered alternative assets.) 

Real estate

Investors often consider real estate to be more “real” or “tangible” than other assets. Interested investors can get involved by:

• Buying physical buildings to rent or sell
• Flipping run-down properties
• Buying shares of real estate investment trusts (REITs) that manage properties for you

These assets can provide streams of income that are helpful when costs are rising. However, property isn’t risk-free. You can still lose money to economic events, interest rate moves, and property damage. (Not to mention the impact of regulatory changes.)  

Commodities

Commodities are physical goods that hold value or can be turned into other goods. This asset class includes agricultural products (rice, chicken, etc.), energy resources like oil, and metals. 

Some investors add precious metals like gold, silver, and platinum to this list. (Others consider “precious metals” a standalone asset class.) 

Commodities’ values move with supply and demand instead of investor whims. As such, they provide benefits like:

• Low correlation with traditional investments (meaning that their value doesn’t always rise or fall at the same time as the value of traditional investments is rising or falling)
• A potential hedge against inflation or price changes in other assets
• The ability to make money on price changes (speculation)

However, commodities can have complex risk-reward factors. Some investors sidestep these risks by investing in companies that produce commodities instead of investing in the commodities themselves. Others buy actual products (like gold bars) or investable contracts (like derivatives). 

Cryptocurrencies

Cryptocurrencies are virtual currencies, like bitcoin or ethereum, that let you transfer value directly to others. The transactions are recorded on networks that prevent tampering and don’t require a middleman like a bank. Like any other asset, the value is based on what the market agrees upon. 

Cryptos offer several paths to investment. You can:

• Buy cryptos on an exchange or brokerage
• Invest in crypto-related ETFs instead of buying coins directly

Investors like crypto because they’re meant to be difficult to steal, counterfeit, or manipulate. You can transfer crypto quickly and usually cheaply, even internationally. And some investors appreciate that they’re not controlled by central governments. 

However, cryptos can also be incredibly volatile, potentially resulting in large losses. Many governments have begun regulating or banning them, impacting their use and value. Plus, with literally thousands of cryptos out there, it’s important to watch out for scams!

How to use asset classes

Once you understand the basics of asset classes, you can put them to work in your portfolio. The following strategies can provide a solid starting point. 

Building a balanced portfolio

Balanced portfolios aim to reduce volatility by investing in both stocks and bonds. The 60/40 portfolio is a common example that invests 60% in equities (stocks) and 40% in bonds.

Many investors use balanced portfolios for long-term goals like retirement. The bond portion can help temper risk and generate income that can be reinvested. Meanwhile, the stock portion may see more ups and downs, but it may also grow more aggressively over time.  

Using funds to diversify quickly

If you aren’t sure about choosing your own stocks and bonds or you just don’t have that much time to focus on it, exchange-traded funds (ETFs) and mutual funds offer an easy way for both new and established investors to diversify. 

When you buy into funds, you’re buying tiny pieces of dozens or even hundreds of assets at once. 

You can buy funds for all kinds of goals, from environmentally friendly to high-growth. You can also target funds that specialize in stocks, bonds, or both. Just be sure to weigh each fund’s strategies, fees, and tax implications before investing.

Mixing up your “style” 

You can also categorize assets within and between classes by “style.” Style refers to what the asset “does”:

• Growth assets are expected to seek higher growth at higher risk. This category may include stocks and some types of real estate and alternative assets.  
• Value assets are assets that investors believe aren’t trading or selling at their true value. They buy these assets now and hope to profit when the asset reaches its “true” price. Warren Buffett famously engages in long-term value investing.  
• Income assets like bonds and high-yield accounts pay regular income to investors. Many are considered lower-risk assets and may generate lower (potentially more consistent) rewards. 

Investors can balance growth, value, and income within an asset class and across classes. For instance, you might generate income with bonds and dividend-paying stocks. Or, you might buy both value stocks and shares in a real estate trust that flips old houses.  

Hedging against inflation

Some asset classes can protect against inflation better than others. 

For instance, you might invest in Treasury Inflation Protected Securities, or TIPS. These government bonds adjust to match inflation twice a year. You can also invest in growth assets or traditional inflation hedges like gold and silver. 

Sure, you can’t guarantee you’ll beat inflation. But smart asset allocation can still reduce the impact of higher prices. 

Defending against economic downturns 

Defensive assets may continue to perform better than their peers during economic downturns. While fitness and tech stocks may sink during a recession, grocery stocks and precious metals may hold their value or even surge. But while they can lessen the impacts of volatility, they’re not invulnerable. 

Targeting asset allocation funds

Asset allocation funds invest in a mix of asset classes based on the fund’s strategy. The fund manager rebalances regularly to keep the fund on track toward its goals. Investors can choose one (or many) based on their goals and needs:

• Balanced funds split the difference between stocks and bonds. The goal: To generate some income while pursuing moderate growth for the future. 
• Growth funds primarily invest in stocks or other higher-risk, higher-reward assets. They aim to grow your wealth quickly.
• Income funds primarily invest in bonds, dividend-paying stocks, and other income-generating assets. 
• Target-date funds aim to generate minimum returns by a set date. They adjust their asset allocation over time as the fund’s target date approaches. 

Keep tabs on your asset classes with Quicken

Understanding asset classes is just one piece of the investment puzzle. The more you invest, and the more you diversify your portfolio with different kinds of investments, often across different accounts, the harder it can be to get a clear picture of your whole portfolio. 

Quicken solves that problem by showing you all your accounts in one place, giving you clear insights into your portfolio’s performance and value — and your complete net worth.