Get to Know Various Types of Asset Classes
- Major traditional and alternative asset classes
- The role of alternatives in a portfolio
- How diversification works across asset classes and investments
What are traditional asset classes?
The major asset classes include bonds, cash and stocks. Bonds and cash have traditionally been viewed as defensive asset classes that many investors use to provide a source of regular income.
Stocks, alternative investments and property, on the other hand, are considered growth assets that aim to boost long-term capital appreciation.
Each asset has its own risk/reward profile. While cash is considered to carry the least risk, it also has the lowest return potential. Conversely, equities and alternatives may carry greater risk but also offer higher return potential.
In uncertain markets, investors may hold larger than usual amounts of cash in an attempt to reduce their risk exposure. It may be possible, however, to prudently take on more risk and incrementally step-up return potential while still managing volatility.
What are alternative asset classes?
There is no single definition of what constitutes an alternative asset class and so the term covers a broad range of investments. Generally, alternative investments encompass those outside the mainstream classes of stocks, cash, and bonds.
Examples of alternative investments include commodities, private equity, infrastructure, real estate, and hedge funds. Previously designed for institutional investors, alternative investments are now available to individual investors through alternative investment funds.
Alternative assets are generally included in a portfolio for two key reasons:
- Diversification: They represent a different source of risk and return for a portfolio.
- Inflation hedge: Inflation can have a big impact on return. Rounding out a core portfolio with non-traditional and inflation-hedging assets can help investors pursue opportunities across economic environments.
For example, in higher inflationary environments, assets such as real estate and commodities may perform better (as illustrated in the chart below).
What’s the role of diversification?
A well-diversified portfolio is split across asset classes as well as among investments within each asset class. Maintaining a diversified portfolio can help investors prepare for shifts in the economy and interest rates, providing the potential to not only capture opportunities but also minimize risks associated with overconcentration in one asset class.
Diversification within equities can be achieved by investing in stocks from different sectors, countries, and companies. Diversification in bonds can be similarly achieved by investing in different sectors, countries, issuers, and bond types.
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