What Are Asset Classes? Definition and MeaningWhat Are Asset Classes? Definition and Meaning
In the realm of finance and investing, you may have come across the term "asset class". This article is designed to help you understand its definition, its meaning, and its significance in your investment journey.
Asset Class Definition
In a nutshell, an asset class refers to a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations. The classification is based on attributes such as risk, return, and the market dynamics that drive them.
The asset class meaning implies that the investments within each class are believed to behave similarly and should, therefore, have the same place in a trader's portfolio. They offer a structured way to diversify a portfolio, thereby helping to minimise risk while maximising return.
How Many Asset Classes Are There?
The next logical question would be, how many assets can we trade? Traditionally, there were three main asset classes - equities (stocks), fixed Income (bonds), and cash or cash equivalents. But, the modern financial markets have expanded this list and now include many others, such as real estate, commodities, foreign exchange (forex or FX), and cryptocurrencies*.
What are the different asset classes? And what is an example of an asset class? Now that we've established a fundamental understanding of what an asset class is let's take a look at the asset classes list and further discuss a few examples to learn more.
Equities
The equity asset class refers to stocks and shares of publicly traded companies. When you invest in equities, you're essentially buying a small piece of ownership in a company. The return on these investments typically comes in the form of capital gains (i.e., selling the stock at a higher price than what you paid for it) or dividends paid out by the company.
However, you can also trade stocks. This won’t bring you dividends but will allow you to trade on a price increase and decline. CFD trading is one of the options. Trading stocks involves researching and analysing numerous factors, including the company's financial health, industry trends, and broader economic indicators, as well as technical indicators and chart patterns. If you want to trade stock CFDs, you can open an FXOpen account.
Fixed Income
This asset class includes investments like government bonds, corporate bonds, and other debt instruments that pay a fixed amount over a specific period. The primary source of return is the interest paid on the borrowed funds.
One of the primary characteristics of fixed-income investments is the regular income they provide. This makes them particularly attractive to those seeking a consistent income stream. Additionally, the risk associated with fixed income is typically lower than that of equities.
Investors in fixed income pay attention to factors such as interest rates, credit quality of the issuer, and the bond's maturity date. Changes in interest rates can affect bond prices, and investors should consider their risk tolerance and investment objectives when selecting bonds.
Cash and Cash Equivalents
Cash and cash equivalents are financial assets that are highly liquid and can be readily converted into cash. These assets are considered to be very safe and easily accessible, making them an essential part of a company's or an individual's financial portfolio.
Cash includes physical currency (coins and banknotes) as well as deposits in bank accounts that are available for immediate withdrawal. Cash equivalents, on the other hand, are short-term investments that are highly liquid and have a typical maturity period of three months or less from the date of purchase. These investments are close to maturity and carry a minimal risk of changes in value due to their short-term nature.
Commodities
This class includes raw materials and resources that can be traded in various markets. They include items like gold, oil, agricultural products, and metals. Commodities are usually used as a hedge against inflation, as their prices can rise when the general price level increases. Additionally, commodities can provide a diversification benefit because their prices are driven by different factors than equities and fixed income.
Commodities are typically traded on futures exchanges. Nevertheless, market participants have the opportunity to tap into the commodity sphere via Exchange Traded Funds (ETFs), diversified mutual funds, and Contracts for Difference (CFD). Commodity trading requires an understanding of the specific market factors that impact each asset. Additionally, commodity prices can be volatile, so risk management strategies are crucial when trading these assets.
Real Estate
Investing in physical properties, whether residential, commercial, or industrial, comes under this asset class. Returns are derived from rental income or selling the property for a profit.
Investing in real estate involves various considerations that differ significantly from those of other asset classes, including high entry costs, management responsibilities, market risk and diversification. Real estate can be directly owned, or investors can gain exposure to this asset class through real estate investment trusts (REITs) or real estate-focused funds.
Cryptocurrencies*
This is a relatively new addition to the asset class family. These digital or virtual assets use cryptography for security, with Bitcoin and Ethereum being well-known examples.
Cryptocurrencies* are decentralised, meaning they are not controlled by any central bank or government. They can be transferred directly between parties via the Internet without the need for a middleman.
You can trade cryptocurrencies* on crypto exchanges or via different financial instruments, including CFDs. When trading a cryptocurrency CFD*, you don’t need to own the underlying asset. You trade on price movements, predicting future price direction based on comprehensive analyses. Trading cryptocurrencies* involves a high level of risk due to their extreme volatility. Therefore, it’s vital to know how margin trading works and understand how to reduce risk exposure with various risk management strategies.
If you want to trade shares, commodities, or cryptocurrencies*, you can try the TickTrader platform.
Investment Asset Classes and Portfolio Diversification
These are the most popular examples of the types of asset classes. The complexity and diversity of these categories signify the importance of understanding the different asset classes before making investment decisions.
Knowing the different instruments and their characteristics is essential for any investor. The key to building a successful portfolio is not just about selecting individual investments but more about allocating funds among these trading categories.
Diversification across financial asset classes reduces risk because different assets react differently to the same economic event. For instance, when inflation rises, it might be harmful to bonds but could be good for commodities like gold. So, a diversified portfolio is expected to balance out the losses in one class with gains in another, stabilising the overall returns.
Final Thoughts
In the world of investing, various asset classes offer distinct opportunities and risks. Equities offer growth potential, fixed income provides stability, commodities offer diversification, cash and cash equivalents provide low-risk opportunities, and cryptocurrencies* introduce new possibilities. When talking about trading, commodities also provide diversification and hedging opportunities; while stocks allow traders to benefit from significant price fluctuations, the high-volatility nature of cryptocurrencies* makes short-term trading exciting. If you are interested, you can trade shares, commodities, and cryptocurrencies* on the FXOpen platform.
*At FXOpen UK and FXOpen AU, Cryptocurrency CFDs are only available for trading by those clients categorised as Professional clients under FCA Rules and Professional clients under ASIC Rules, respectively. They are not available for trading by Retail clients.
This article represents the opinion of the Companies operating under the FXOpen brand only. It is not to be construed as an offer, solicitation, or recommendation with respect to products and services provided by the Companies operating under the FXOpen brand, nor is it to be considered financial advice.
