Wilmington Trust

Asset Classes

When investing, you may hear references to "asset classes." Assets are various types of securities available to you to choose from as an investor, each with its own characteristics, as well as ranges of risk and reward. Each "class" is a group of securities with similar characteristics. When building a portfolio, there are five basic asset classes you should be familiar with:

Stocks

Stocks allow you to own a portion of a public corporation. Initially, they are sold by the original owners of a company to gain additional funds to help the company grow. This is called the Initial Public Offering. The owners sell control of the company to the stockholders. After the IPO, the shares are resold on the stock market.

Bonds

A bond is an investment in which an investor loans money to an entity (typically corporate or governmental), which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states, and sovereign governments to raise money and finance a variety of projects and activities.

Real Assets

Real assets are physical assets that have value due to their substance and properties. Real assets include precious metals, commodities, real estate, agricultural land, machinery, and oil.

Nontraditional Assets

An asset or strategy that seeks to earn returns in a manner not wholly dependent on the direction of public equity and debt markets. Certain of these may have limitations on (or no) liquidity and may have irregular reporting and otherwise be difficult to value.

Cash Equivalent Securities

Investments in securities characterized by high quality and short terms to maturity and/or high liquidity. U.S. Treasury Bills and money market mutual funds are common examples.

Stocks

Stock represents fractional ownership of a company. Sometimes stocks are referred to as equities, similar to equity in a home. They are priced based on the valuation of the company.

Pros

Stocks represent partial ownership in a company so you may share in any profits.
Stocks typically perform well during economic expansion.

Cons

Price changes can be quite volatile compared with fixed income securities
Stocks may become worthless if the company goes bankrupt.

Bonds

A company or government can raise capital by borrowing and incurring debt. They can do this by issuing bonds or other debt instruments to investors.

Pros

Generally provide a more stable value, compared to equities
Have a mandated repayment schedule
Tend to hold value better than other asset classes during economic declines
Typically offer a steady, regular cash flow

Cons

Generally provide a lower expected long-term return on investment
Certain bonds can mature early, and the investor may not be able to find another bond paying the same level of interest (reinvestment risk)
Many bonds are issued with long-term (more than 10 years) maturities

Stocks vs Bonds

If a company grows, stock prices would be expected to increase, while bondholder participation is fixed at the return of their principal plus the agreed-upon interest rate. If the company loses value, stock prices would be expected to drop. Meanwhile, as long as the company does not file for bankruptcy, bondholders would still receive the amount of funds they lent, plus interest.

Cash equivalent securities

Cash equivalent investments include savings accounts, money market certificates, and commercial paper.

Pros

Typically reach maturity in a shorter period than other forms of investments
Trade in liquid markets or otherwise easily converted to cash
Are less subject to price swings than longer-dated bonds

Cons

The interest rates paid are usually relatively low
Given the low rates, holding too much cash can be seen as an opportunity cost relative to other investment options

Real assets

Real assets are interests in tangible assets, which have value due to their substance and properties and have been favored during inflationary times. Real assets can play an important part in an investment portfolio—including conservative and income-oriented portfolios. Real asset exposures tend to represent an ownership interest (real estate investment trusts, mutual fund, or possibly futures or other derivatives) and include:

Commodities, including precious metals (gold, silver, etc.), industrial metals (steel, iron, etc.), agricultural products (wheat, sugar, etc.)
Real estate, including Real Estate Investment Trusts (REITs) and other property interests
Inflation-linked bonds, including domestic and foreign issued bonds

Nontraditional assets

Typically used to help diversify a portfolio, nontraditional investments are generally grouped broadly into two categories—hedged strategies and private markets.

Hedge Funds: A range of strategies that seek to earn a return that is not solely dependent on markets increasing in value
- “Liquid” hedge funds are mutual funds, offering next-day liquidity
- Hedged strategies are often accessed through private funds (covered in our next module), which may offer some liquidity, though often with significant limitations, such as 1 or 2 year lock ups, gates, and only quarterly redemptions.
Private Markets: A long-term investment in assets that may not be traded in public markets and do not provide the ability for investors to liquidate

Hedge strategies are offered in relatively liquid mutual fund investments that can be available to all investors and also in private fund structures that are only available to qualified investors who are deemed sufficiently sophisticated to assess, or engage a professional to assess, the potential benefits and risks of such offers. Private markets are typically available only to qualified investors via private funds. To qualify for private placements, investors must meet the accredited investor standard and often also the qualified purchaser standard, both of which are imposed by regulators based on income and investable asset thresholds, among other considerations, as a proxy for sophistication.

Important considerations while investing in asset classes

Investing in business cycles
One of the reasons why investment managers spend time analyzing and forecasting economic trends is that certain asset classes have historically performed better in certain economic conditions.

As you can see from this graph, stocks are preferred when the economy is expanding, but bonds are preferred when the economy is declining. Also, particular types of stock have performed better at different stages in the cycle.

Different Types of Investments

Have performed better at different stages of the economic cycle.

Costs associated with investing

Depending on the asset class or investment type, some institutions may charge various fees. These include:

Account set-up and annual maintenance costs
Fees for not maintaining a minimum balance
Commissions to brokers as a percentage of the products sold
Markup on shares purchased through a middle-man
Borrowing for short-sale or margin purchases
Asset management fees
Capital gains taxes

Next: Ways to Invest Your Assets
previous: Why Invest