^{Building Wealth} Classifying primer asset classes for smarter investing

From risk to return: Why asset classes matter?

An asset class is a group of financial instruments which have similar characteristics and comparable behaviour to market fluctuations. Usually there is very little or negative correlation between different asset classes. Different asset classes provide different types of returns, risks, liquidity, and market volatility for investors. Financial advisors use asset classes as a way to help investors diversify their portfolios and maximise returns.

Understanding asset classes: From stocks to commodities

1. Equities (stocks), fixed income (for example, bonds), cash, real estate and commodities are common examples of asset classes.

• Equity represents ownership, whether partial or complete, in a company. It equals the amount of money that would be returned to a company's shareholders if all the assets were liquidated and all of the firm’s debt was paid off in the case of liquidation. An equity investor expects to gain through dividends and/or growth in the value of the company.
• Equities can be further classified based on market capitalisation into small-cap, mid-cap, and large-cap stocks or by factor style (growth, value, blend).
• Equity mutual funds are mutual fund schemes that predominantly invest in shares of companies. They can further be sub-classified on the basis market capitalisation, sector, or factor style (growth, value, blend).

2. Fixed-income assets are investments in debt instruments that provide a return in the form of fixed returns until maturity. Broadly, it includes bonds issued by governments and corporations, certificates of deposit, mortgage-backed securities, and more.

3. Alternative Asset Class is an asset class that does not fit in traditional asset classes like stocks and fixed income. Alternatives include a wide range of assets like private equity, hedge funds, real estate, private credit etc. This asset class is generally illiquid, carries higher risk, and is complex in nature.

4. Real estate includes land and property. Investment in real estate may involve both direct investment into physical land and/or property, and indirect investments via the use of vehicles such as Real Estate Investment Trusts (REITs).

• A real estate investor may seek rental income and/or growth in the value of the real estate. REITs are basically dividend-paying stocks.

5. Commodities usually refer to raw materials such as oil and gold. Investors can buy and sell commodities directly in the spot market or through derivatives such as futures and options. Including commodities in a portfolio can help investors hedge against inflation as their prices typically rise when inflation accelerates. Commodities are also a good diversification option as they do not typically trade in tandem with stock and bond markets.

6. Forex trading involves the conversion of one currency into another. It may offer fast profits to investors with deep pockets, but it can also expose them to substantial losses. Unexpected events can lead to sudden market moves and high volatility, making foreign exchange (forex) trading a high-risk exercise.

7. Derivatives are financial contracts between two parties that derive their value from an underlying instrument. They are typically used for hedging market or systematic risks such as returns rates and market movements, currency fluctuations, commodities and inflation.

Additional factors for asset class classification

There are several ways to classify assets.