Asset Classes New and Old
Asset classes are groupings of investments that have similar offerings or characteristics. What are the some of the major asset classes? What are the expected returns and risks of each? Here are the most common asset classes as well as the birth of a new one, what they historically have returned and the risk of holding that asset class at any given time or over the long run.
Cash and Cash Equivalents
Many investors hold a percentage of their holdings in cash as a way of maintaining liquid assets or simply providing safety and comfort in volatile times. Cash is currency and the cash equivalents include products such as Treasury bills or notes, Money Market, Commercial Paper, etc.
Currency is currency and so for both cash and cash equivalents, there is a price to pay for the liquidity and safety. Cash equivalents usually have a lower yield when comparing against other asset classes
Cash has very low risk, and offers relatively low returns. The returns for these investments have been close to the inflation rate, averaging about 3% per year over the past 80 years. Looking forward, you can probably expect that the real return on these investments which is adjusted for inflation will be essentially zero, so don’t expect the money invested here to grow or really even keep pace.
Fixed Income or Bonds
Fixed income generally refers to those types of investments that pay investors fixed interest or dividend payments until a maturity date. At maturity, investors are repaid the principal amount they had invested.
The most common fixed-income investments are bonds. Government and corporate bonds are the most common types of fixed-income products. For example, Treasury bonds, government and agency bonds, municipal bonds, corporate bonds, and mortgage-backed securities, as well as certificates of deposit.
As the name implies, the yield on fixed income assets is fixed. You can generally determine your expected return when you first invest, but typically won’t make more than that. There are four key features in this asset class: diversification, capital preservation, income generation, and potentially favorable tax treatment.
The offset in fixed income is that they are subject to various risks including; changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in fixed income securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term securities or lower-rated and non-rated securities.
Real assets are based on tangible things and the big 3 are real estate, infrastructure and commodities. Unlike other asset classes, the value of listed real asset investments comes from the physical nature of their underlying assets.
The inherent characteristics of each real asset can vary, but they all have several features in common. Real assets can offer the opportunity for diversification, inflation hedging and competitive total return potential. Real assets may also serve as a nontraditional source of income, a feature that investors frequently overlook.
Real assets can appreciate in value though in some cases to realize the returns, you may need to sell the asset.
Investments in real estate can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties. Investment properties can also provide income, and because rents often increase with cost of living, this can help investors combat inflation.
Commodities earn returns based on supply and demand versus profitability. Whether that be oil, gold, or corn they all follow the same underlying price structure. Special risks associated with an investment in commodities include market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors.
Equities are ownership shares of a company. Equities are pieces of a company, also known as stocks. When you buy stocks or shares of a company, you’re basically purchasing an ownership interest in that company. A company’s stockholders or shareholders all have equity in the company.
There’s a wide variety of ways to own a portion of a company, from publicly traded shares to funds that own stocks and even investments in privately held companies. Equity investors purchase shares of a company with the expectation that the shares will rise in value in the future, and/or generate dividends.
If an equity investment rises in value, the investor would receive and recognize the gain by selling the shares. When a company appreciates in value, your share of the company is worth more, too. A those returns that can come in two ways (appreciation and dividend payments), both driven off the company’s earnings.
It’s possible for you to lose money, including your principal investment. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. Remember the trade off for potential higher return is higher risk.
Crypto and Digital Assets
It is not very often we see the birth of a new asset class but that is exactly what is happening with cryptocurrency and digital assets. A cryptocurrency is a form of digital asset based on a network that is distributed across a large number of computers through the blockchain. They enable secure online payments without the use of third-party intermediaries.
Experts believe that blockchain and related technology will disrupt many industries, including finance and law. It is still early but the blockchain has already created smart contracts as well as NFT’s so who knows what else will follow. NFTs are important because they are digital certificates of authenticity and can establish proof of ownership for virtual assets.
The advantages of cryptocurrencies include cheaper and faster money transfers and decentralized systems that do not collapse at a single point of failure. The risk in investing in cryptocurrencies is that there is no guarantee that any given crypto project you invest in will succeed.
Competition is fierce among thousands of blockchain projects. Only a small number of cryptocurrency projects will ultimately flourish. Regulators may also crack down on the entire crypto industry, especially if governments begin to strongly view cryptocurrencies as a threat rather than just an innovative technology.
The potential reward in the birth of a new asset class is that some Crypto investors have already enjoyed life-altering returns in a very short time frame. Remember this is a fast moving environment where things can change quickly in terms of losers and winners but the ability to be on the forefront of life changing technology and innovation that will affect the masses cannot be ignored.
Bottom line is do your research, understand the risks factors, compare against your risk tolerance and map out what you are trying to accomplish. Many times, you can reverse engineer what you are trying to accomplish to a specific asset class or group that makes sense for that situation, need or goal.