Looking to diversify? Its a two edged sword that can protect capital and limit gains. Read now to learn five asset classes you should have in your portfolio.
Five Asset Classes All Investors Should Own
Investments and investing is good, but what do you invest in? The answer to this assets,cash or wealth producing items that can be bought and sold, but even this does really answer the question. Breaking it down a little further is asset class, the subject of this discussion. Asset classes are the commonly recognized divisions of assets, such as equity, commodity and currency. The lines have blurred in today’s market as there are derivative investment vehicles flooding the market, offering investors the chance for diversification and profits at every turn.
Commodities – A commodity is a raw material used in the manufacturing or operation of business. These include but are not limited to things like cotton, sugar, pork bellies, gold and oil. Prices for these goods are set on the open market based on quality and demand. Buyers and sellers trade contracts for lots, standard amounts, which can be for immediate delivery or delivery sometime in the future. The average investor can gain exposure by buying stock in companies that produce commodities, or in a fund that tracks an underlying commodities price. Commodities tend to do well early in an economic recovery.
Equities – The term equity or equities can refer to any asset in which a person can buy a share. The share is an equity, or equal, portion of ownership. In this case the term is referring to stock issued by a business. Each share of the stock represents a portion of ownership in the underlying company and entitles the bearer to a portion of the companies assets and profits. The purpose of owning equities is two fold. The first is to benefit from the companies success, usually in the form of cash dividends or other distributions. The second is to benefit from a companies growth, as the business grows so too will the value of the shares.
Bonds – Bonds are a form of debt in which buyers give a loan in exchange for interest payments and eventual repayment. Bonds are issued by countries, states, cities and businesses and classified in terms of credit worthiness. Lower risk bonds are referred to as investment grade while the most risky are called junk bonds. Lower risk bonds like US treasuries or German Bunds come with lower yield, typically in a range below 5%. Higher risk junk bonds come with higher interest rates, as high as 10% and more depending on the risk. This means it cost more for a business with a lower credit rating to borrow from the public.
Real Estate – Real estate is anything having to do with land, the buildings upon it or the use of said land and buildings. It can be as simple as owning an apartment building to leasing office space or land for agricultural or mining purposes. Properties can be bought and sold for profits, or used to generate income.
Mutual Funds, CEF’s and ETF’s – Mutual funds, closed end funds and exchanged traded funds are where the lines between asset classes become blurry. These are structured investments based on an underlying asset class or strategy that trade on the stock market just like an equity. The fund is usually an incorporated business in which managers, either active or passive, track the results or invest in a commodity, industry or business sector. Actively manage funds seek to outperform the sector upon which it is based while passively managed funds tend to track an index or sector.
Diversification – Diversification is the practice of spreading investment capital among multiple investments. This is done for several reasons including risk reduction and enhanced returns. There is always risk an investment will turn so keeping exposure to any one investment low risk is reduced. At the same time, by investing in more than one asset class portfolios can produce profits in up and down markets. Many investments, such as gold for the dollar, are seen as a hedge and trade opposite to each other. A hedge is an investment that off-sets losses in another asset when the market moved unexpectedly.