We did it again. We dropped some terminology in last week’s blog post and people want to know more about it. This week it’s asset classes.
An asset class is a group of investments that may have similar risk and return characteristics. Generally, there are four asset classes:
1. Cash and Cash Equivalents
2. Fixed Income Securities
4. Alternative Investments
Cash and Cash Equivalents:
This can include cash in a savings account, guaranteed investment certificates (GICs), treasury bills and money market funds. All these investments are considered to be very safe and have very low risk for investors. They also typically offer quick access to your cash. However, with the lower risk comes a lower rate of return.
This includes bonds and other debt instruments. It is a loan to a company or government for a certain period of time. After that period has passed the company or government will pay you back your principal investment plus interest. Fixed Income Securities are also considered to be a low risk, safe investments, however they do on average pay a better return than cash and cash equivalents due to some increased risk. There are also higher risk fixed income securities such as junk bonds.
Equities are stocks, or shares you purchase in a company allowing you to take an ownership stake in the company. This may offer you special privileges such as voting rights within the company. Equities make money in one of two ways. One, if the stock price increases allowing the investor to sell it for a profit. Two, if the company pays investors dividends. There is no guarantee that the stock’s value will increase and a company does not have to pay dividends to shareholders. Equities have the potential to pay high returns, but they come with much higher risk than cash and cash equivalents and fixed income securities.
Alternative investments include things like derivatives such as options and futures, hedge funds, foreign currencies, and income trusts. They are complex investments that are usually only suitable for sophisticated and knowledgeable investors. Due to their complexity, alternative investments have higher-than-average risks and higher-than-average returns. Due to their higher risk, alternative investments are typically meant for investors that can afford to take this increased amount of risk.
Some of you may be asking which asset class do mutual funds fall under? The quick and easy answer is possibly any and all of them. Since a mutual fund is a collection of investments they can draw from any of the asset classes. It could be a combination of bonds, stocks, or alternative investments. Because of this they do not necessarily fall under one asset class.