What is an Asset Class?
So you are ready to invest, but you aren’t sure where to start. Will the right stock help you win big? Will bonds help you play it safe? Does a rental property count? What’s the difference between all these options, anyway? Here is an overview of potential assets and asset classes for the green investor.
At the most basic level, an “asset” is any resource that’s owned or controlled by an individual, corporation, or government with the expectation that they will generate future cash flows. It’s effectively anything you can invest in — stocks, bonds, collectibles, commodities, etc.
How are Assets Classified?
In general, assets are classified based on three factors.
- Convertibility: This classifies assets based on how easy it is to convert them into cash. Current assets, or liquid assets, can easily be converted into cash. These include cash, short-term deposits, stock, marketable securities, and office supplies. Non-current assets, also called fixed assets, cannot be easily converted into cash. These include land, building, machinery, equipment, patents, and trademarks. Convertibility, or liquidity, is generally considered a perk for particular assets and asset classes.
- Physical Existence: The second way that assets are classified is based on their physical existence or lack thereof. Tangible assets physically exist and include land, building, machinery, equipment, cash, office supplies, stock, and marketable securities. Intangible assets do not exist physically and include goodwill, patents, brand, copyrights, trademarks, trade secrets, permits, and corporate intellectual property. Intangible assets, such as brand, can greatly impact an asset’s (such as a company’s stock) valuation.
- Usage: Operational usage classifies assets as either operating or non-operating. Operating assets are used as part of daily operations to generate revenue and include cash, stock, building, machinery, equipment, patents, copyrights, and goodwill. Non-operating assets may generate revenue, but they are not used in daily business operations. These include short-term investments, marketable securities, vacant land, and interest income from a fixed deposit.
Asset Classes and the ‘Risk Ladder’
Asset classes are simply groupings of similar types of investments, as defined by the factors listed above. Shares of stock from a variety of different companies are all part of the stock (aka equities) asset class. Gold, silver, oil, etc are all part of the commodities asset class. And the asset class for collectibles can include everything from art, to classic cars, to antiques and more.
Asset classes are also helpful for investors in that they are ranked by risk level according to a “risk ladder.”
What are the Major Asset Classes?
Major asset classes in order of least risk to most risk are as follows:
Cash or Cash Equivalents: Money in a bank account or elsewhere. It doesn’t get much safer than cash, but the growth potential of these holdings are essentially limited to whatever interest is paid on your accounts.
Bonds: Bonds are certificates of debt that you can buy from a company or government that allows you to earn regular interest on each bond that you hold. Bonds typically pay investors on a monthly or quarterly basis.
Stocks: Shares of stock are essentially pieces of a publicly traded company that investors can buy and hold on a stock exchange as a way to profit on the growth of that company. Some stocks also pay investors dividends, a form of income or profit sharing, on a regular basis.
Mutual Funds: Mutual funds are funds that are pooled from multiple investors and invested in securities such as stocks, bonds, and short-term debt. Because mutual funds are made up of a diverse group of securities and they allow investors to diversify their portfolios with only one purchase.
Exchange Traded Funds (ETFs): Like mutual funds, ETFs are a collection of securities containing stocks, commodities, bonds, or a mixture of investment types. Whereas mutual funds are valued at the end of each trading day, ETFs are traded and valued throughout the day and are bought and sold on a stock exchange just like regular stock shares.
Alternative Investments: A broad asset class, alternative assets include real estate (such as a piece of property), hedge funds (a grouping of assets), private equity funds (capital raised by a company without going public), commodities (natural resources or otherwise), art and collectibles and more. Anything that you can buy with the expectation that it will increase in value can be considered an alternative investment.
Each type of asset and asset class carries different perks and limitations, such as liquidity, both for retail and institutional investors. Determining which mix of assets and asset classes are right for an investor should be a methodical and well-researched process based on an investor’s long-term investment strategy.