Asset Classes: Meaning and Different Types

Welcome aboard our fascinating adventure into the world of investments! If you are reading this, you are about to venture on an immensely interesting path that will not only develop your financial knowledge but also provide you with the skill to make your money work for you.

In this module, we touch on the investment sector, focusing on asset classes and money lending. But what are we actually speaking of here? Well, imagine a basket. In the investment arena, this basket can be a mix of various kinds of assets, each with its unique features, risks and probable returns. Different assets are groups that we call 'asset classes.'

You might wonder, "What's in it for me?" 

Picture this: you've saved ₹10,000 from your summer job or a festive gift.  Instead of leaving this money sitting idle in your piggy bank or savings account, learning about asset classes can help you grow this amount into a larger sum. Growing a tree from a seed is like that.

Let us look into the types of asset classes in this chapter, such as stocks, bonds, real estate, etc. Each of these can be a part of your investment strategy, and the difference in risk and potential rewards will be discussed. By the end of this chapter, you'll know where to invest your ₹10,000; that will depend on your own goals and the level of risk you're OK with.

So, buckle up and get ready to dive into the world of asset classes.

What are Asset Classes?

Let's break down asset classes for you in a simple way.

Now, suppose you are at a buffet. We have various types of food served – starters, mains, desserts, and beverages. Every food is like a separate category in the buffet. In the investment world, similar asset classes are the categories where you can invest your money. They are portfolios of investments sharing similar financial traits, belonging to the same regulatory and legislative frameworks, and exhibiting similar behaviours in the marketplace.

Here are some key pointers for you to keep in mind with respect to asset classes: 

• Variety in Investing: Just as a buffet provides different types of foods, the world of investment comprises multiple asset classes. Diversification is highly important - it's more like not placing all your eggs in the same basket. If one investment goes down, others can support it.
• Risk and Return: Each asset class has its own risk and potential return. Think of it as being between spicy and mild food. Some investors enjoy risky, high-yield options, and others go for lower-yield but more secure investments.
• Changing Over Time: Asset classes can evolve similarly to food trends. Staying abreast of the news and tweaking your investment strategies accordingly is critical.
• Common Types: Stocks (equity), bonds (debt), real estate, commodities, and cash equivalents are common asset classes.
• Importance: Awareness of investment classes leads to a proper and diversified portfolio which is a blend of various means to eliminate risk and to return.
• Goal Alignment: The same way you choose food that fits your health goals, pick asset classes that match your financial goals and risk tolerance. A careful combination will help you to achieve those goals efficiently- from purchasing a bicycle to retirement planning.

With the basics in place, let’s now look at the different types of asset classes. 

Types of Asset Classes 

As we mentioned earlier, there are different types of asset classes that have differing risks and offer varied returns. Needless to say, it is of utmost importance to know these asset classes so that you’re well-informed on this journey. 

If you’re the impatient kind, here’s a quick table summarising the different asset classes. For more details, please keep reading on. 

Asset Class	Characteristics	Risk Level	Example
Cash & Cash Equivalents	Easily accessible, low-risk assets	Low	Savings account
Fixed Income	Regular income, lower risk	Moderate to Low	Government bonds
Equities (Stocks)	Ownership in companies	High	Shares in Reliance
Commodities	Physical goods, market-dependent value	High	Gold, Silver
Real Estate or Other Tangibles	Physical property or assets	Varies	Apartment in Mumbai

Cash and Cash Equivalents

Cash is exactly what it sounds like – the money you have in hand or your bank accounts. Cash equivalents, on the other hand, are short-term investments that can be quickly converted into cash with minimal risk of change in value.

The key characteristics of cash and cash equivalents are high liquidity and low risk. This means they can be readily accessed and have a minimal chance of decreasing value.

Some of the examples of assets in this class include: 

• Cash, in the form of physical currency or money in a bank account. 
• Treasury bills that are backed by the government. 
• Short-term mutual funds, high-quality debt instruments. 
• Certificates of deposit, or time deposits with the bank, wherein you leave a sum of money with the bank for a fixed period and get some guaranteed interest in return. 

If you’re wondering if these assets should be a part of your portfolio at all, well, the answer is yes, for the following reason: 

• With cash by your side, you’ll always be ready to jump on any investment opportunity that arises without having to liquidate any other assets. 
• Cash and cash equivalents are good safety cushions against market volatility. 
• These are ideal for short-term goals like saving for a vacation or emergency. 

While cash and cash equivalents are low-risk, they also offer lower returns compared to stocks or real estate. Inflation is another factor to consider, as it can erode the purchasing power of your cash over time.

Fixed Income

Fixed income describes investments that pay you consistent, unchanging interest payments until the due date, after which your initial investment is returned. It's analogous to borrowing money and then getting the principal back plus interest.

Reliability is the trait of fixed-income investment. They provide regular income and are typically regarded as a safer option compared to stocks.

Some examples of fixed-income investments include: 

• Government bonds
• Corporate bonds
• Fixed deposits
• Municipal Bonds
• Treasury Inflation-Protected Securities (TIPS)

There are various benefits of having fixed-income investments in your portfolio, including: 

• They give a regular and consistent income flow.
• A fixed-income investment in a portfolio will lower its volatility.
• Fixed income investments work for those who are almost retiring or those with little appetite for risks.

This doesn’t mean there aren’t risks connected with these investment classes. To begin with, if the interest rates rise, the value of previous bonds can go down. Moreover, the possibility of the issuer defaulting remains there. Lastly, the fixed returns that do not increase might be insufficient to outperform inflation - thus causing a drop in purchasing power.

Equities

You're essentially buying a piece of a company when you buy equities. As a shareholder, you own a fraction of the company's assets and earnings. You're a part-owner, however small your share might be. Equities are known for their potential for high returns, which comes with higher risk. The value of your shares can go up or down based on the company’s performance and market conditions.

Some of the examples of equities include: 

• Stocks of individual companies like Reliance, Infosys, and so on. 
• Stock mutual funds. 
• Exchange-traded funds.
• Dividend stocks
• Growth stocks

The equities asset class comes with its distinctive set of advantages that seems appealing to many: 

• Equities generally offer higher returns than other asset classes over the long term – though this comes with higher volatility. 
• With equities, you can easily diversify your portfolio, thereby reducing risk and improving returns. 
• Stocks can be liquidated very quickly and easily. 
• Depending on the type of stock you own, owning shares might sometimes grant you voting rights in the company’s decisions. 

With greater rewards come higher risks, you already know! And that’s true for equities as well. Share prices fluctuate based on market dynamics, which is highly unpredictable and can lead to potential losses if market conditions are not studied properly. Further, the volatility of equities can be unsettling to some people. Additionally, buying shares in a company always comes with company-specific risks, which is another unknown variable. 

Commodities

Commodities, the raw materials that are either consumed directly or used to make other products, form a unique asset class in the investment landscape. Investing in commodities offers an opportunity to diversify and hedge against inflation while adding a different dimension to your portfolio.

Commodities are tangible and cover a wide range – from metals like gold and silver to energy sources like oil and natural gas and agricultural products like wheat and coffee. Their prices are driven by supply and demand dynamics, often making them more volatile and influenced by global economic and political factors.

Some of the common examples of commodities include: 

• Precious metals like gold, silver, and platinum. 
• Energy includes crude oil, natural gas, and coal. 
• Agricultural products like corn, soybeans, coffee, wheat, etc. 
• Base metals like copper, nickel, and aluminium are extensively used in construction and manufacturing. 

Investing in commodities offers unique advantages, some of which include; 

• Direct physical ownership of costly tangibles. 
• Commodities have a low correlation with stocks and bonds. Therefore, they can provide a sort of balance to your portfolio. 
• Serves as a hedge against inflation, even while the purchasing power of a currency declines. 
• Exposure to global economic trends. 

Again, there are risks of volatility with this asset class. Prices of commodities can be influenced by various unpredictable factors, which makes things even more difficult. Further, storage and insurance add to the base costs when it comes to commodities. 

Real Estate or Other Tangibles

Real estate investment involves buying property, whether residential, commercial, or industrial. Other tangible assets include physical items like art, antiques, rare collectables, and even precious metals (though these can overlap with commodities).

These assets are tangible, meaning you can touch and feel them. They often provide a dual benefit – practical utility and potential appreciation in value. In the case of collectables, their worth is influenced by factors like location, physical condition, market trends, and rarity and historical significance.

Some of the examples of this asset class include: 

• Residential homes and apartments – whether you’re living in them or renting them out. 
• Commercial properties like office buildings, warehouses, retail spaces, etc. 
• Raw land for development or agricultural use. 
• Art and antiques, including sculptures, vintage furniture, rare collectibles, etc. 
• Other physical assets include rare stamps, coins, high-end watches, vintage cars, etc. 

The benefits of investing in this asset class are pretty much the same as those that we talked about for commodities in the previous section. In terms of risks, however, this asset class comes with the added risk of maintenance and upkeep of your precious tangibles. Further, this asset class suffers from high entry costs! 

Investment Strategies as Per Different Asset Classes

Finally, let's stroll through the garden of investment strategies tailored for different asset classes. Just like each plant in a garden requires a unique approach to thrive, each asset class flourishes with a specific investment strategy. Let's dig into this!

Asset Class	Strategy	How to Use
Cash and Cash Equivalents	The 'Safety Net'	Keep enough for emergency funds and short-term needs, like a first-aid kit.
Fixed Income	The 'Steady Eddy'	Balance the volatility of other investments. Like a dependable tree providing shade.
Equities	The 'Growth Seeker'	Ideal for long-term goals. Diversify across sectors. Like planting a variety of flowers.
Commodities	The 'Market Maverick'	Allocate a smaller portion of your portfolio. Like the exotic plants in your garden.
Real Estate or Other Tangibles	The 'Long-Term Player'	Invest in growth areas or rent out. Like planting a tree for long-term growth.

As we conclude this chapter, remember that investing is a personal journey. Your investment strategy should align with your goals, risk tolerance, and time horizon!