The Three Basic Asset Classes Explained

When it comes to investing, understanding the basic asset classes and the sub-classes within each is mandatory. It not only helps when it comes to portfolio construction but in knowing where to invest. So, without further delay, let's examine the three basic asset classes:

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1. Cash and cash equivalents. In this asset class, investors will hold actual cash or short-term, liquid securities such as 30-day treasuries. While interest is often paid on assets invested in this class, the investment objective is simply to have access to money when it is needed.

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2. Income. In the income asset class, investors are seeking "income" in terms of interest and dividends as a primary investment objective. Since income can be derived from different sources, there are many different sub-classes to this asset class including:

a) Government. In this sub-class, investors will seek returns from government bonds exclusively. There are many different types of government bonds, including Federal, State and Municipal.

b) Term deposits. Here, investors are guaranteed a rate as well as their principal. This sub-class can be further classified into long-, mid- and short-term.

b) Corporate/High Yield. Here, investors will look at high yield investments as the source of income. Typically, the riskier the bond, the higher the rate. This sub-class can be further classified into additional categories including investment-grade and junk bonds among others.

c) Preferred Shares. With preferred shares, the investors received dividend income.

3. Growth. In the growth asset class, investors are normally investing in stocks or other speculative investments. The key with the growth class is that investors want to see their investment grow (e.g. a ,000 investment will grow to ,000) regardless of whether such investments pay any type of income (such as dividends). The growth class has many different sub-categories including:

a) Large, Mid and Small Cap. Growth investments can be categorized by the market capitalization of the securities in that class.

b) Dividend-Paying. In this class, the growth-oriented securities will pay dividends. Although the dividends provide income, it may not be steady and the primary objective, even with dividend-paying investments, is to realize growth.

c) Growth or Value. Securities can designated as either growth or value. A growth security is one that is expected to enjoy steady growth as predicated by historical trends; a value security is one that is perceived to be "cheap" or undervalued. These sub-asset classes are not one and the same and it can often be debated as to which camp (growth or value) a specific equity belongs.

d) Geographic. The growth asset class can be sub-categorized by the area in which the securities operate or are based. For example, domestic growth refers to US-based equities whereas Latin American growth will refer to securities that have business operations or are based out of Latin America.

e) Sector specific. These asset classes can be specific to a given industry, such as real estate, resources, energy, manufacturing and so on.

When it comes to the growth asset class, the securities can fit many different sub-classes as well. For example, you can have a large-cap, domestic, dividend-paying, manufacturing-based equity. Again, this list is not intended to be exhaustive. It provides a very broad overview of the different asset classes in which investors can dabble.

The Three Basic Asset Classes Explained

Understand the importance of Asset Allocation at MutualFundSite.org. Chris has more than 16 years of experience in the financial services industry. He is currently the Fund Advisor for the Mutual Fund Site at MutualFundSite.org.

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