The Six Asset Classes

Depending on who you ask, you will find that there are varying opinions on the different types of assets out there that you can invest in. In my opinion there are six basic asset classes, plus an extra category we may call “alternatives”.

The main point here is to avoid confusion with investment products. There are thousands of products available, all packaged up with pretty brochures and power point presentations, but the majority of these products are simply investing in one or more of the six basic asset classes.

Let’s start with some simple definitions:

1. Cash – a means of exchange and a store of value.
2. Bonds – government or corporate debt.
3. Equities – stocks and shares representing an ownership interest in a company.
4. Property – a building or buildings and the land belonging to it or them.
5. Commodities – raw materials or primary agricultural products that can be bought and sold.
6. Collectables – items valued and sought after by collectors.

Cash is sometimes confused with currency, but they are not the same thing. If I have ¥10,000 and I step outside my house in Japan and wander into town, I can exchange this for goods and services readily. If I get on an plane and fly to the UK, can I do the same at my destination? The answer, of course, is no. I first need to exchange my Japanese Yen for British Pounds, and this is done at a market determined rate that can fluctuate from minute to minute. The JPY I hold has become a commodity that can be bought and sold.

Bonds are complex instruments, but they have some basic characteristics we can recognise: they have a creditor, who is the bond holder, and a debtor, who is the bond issuer. Bonds have a face value, which represents the amount of principal the bond holder will receive at maturity, and is the amount the issuer pays interest on. They also have a market value, which is what people are willing to pay for them today. They have a maturity date, when that nominal face value amount is typically repaid. They also have a coupon, which is the interest rate the issuer pays to bond holders.

Most people are familiar with the idea of equities or stocks in publicly traded companies. However, it is also possible to own stock in private companies, known as private equity. Private equity is not a separate asset class, however it is less liquid and carries different kinds of risks to investing in listed companies.

For some people property is the simplest asset to understand because it is tangible – you can see it and touch it. Property comes in many different forms: land, buildings, houses, apartments and even collective investments. It’s possible to buy a property fund or Real Estate Investment Trust (REIT) that gives you exposure to the asset class, but with a lower investment amount and potentially higher liquidity. The ability to borrow money to invest in physical property makes it a potentially powerful asset class.

Commodities are exciting due to the high level of price fluctuation, or volatility. This means there are many opportunities to buy low and sell high and make money. It’s also very easy to get it wrong and lose money. Commodities used to be for expert traders only, but these days, with the advent of Exchange Traded Funds (ETFs), it’s simple for anyone to invest in gold, oil or even coffee.

Collectables are about more than just a hobby. An educated investor can make incredible returns  buying and selling artwork, stamps or antiques. However it takes a significant level of knowledge and expertise to make money in collectables and it’s easy for amateurs to get duped. You may want to hang onto that heirloom your grandparents handed down to you though!

As I said, the majority of investment products can be fit neatly into one or a combination of these six categories. However there are “other” investments that may not fit in perfectly. Hedge Funds have long been touted as an asset class all of their own, although I would argue that most hedge funds simply invest in a combination of the above asset classes, albeit it an innovative or original way.

For the average individual investor, concerned with saving and investing for their future, a solid understanding of the six basic asset classes, and the risks and trade-offs associated with them is more than enough to get them started on the path to building wealth.