What Are Asset Classes? - Personal Finance for Complete Beginners

For those who are new to the world of investing, the term "asset classes" may be incomprehensible. However, it's not as complicated as it sounds. "Asset" is another word for a type of investment, and in this case, "Class" is just a way of categorizing different types of investments. The three major asset classes are equities, fixed income and real estate. Real estate is obvious, but the other two may not be, so we'll concentrate on those two asset classes here. A solid understanding of asset classes is essential for developing a good asset allocation.

"Equities" are just stocks by another name. However, this asset class can be broken down further into domestic or international stocks, large-cap, medium-cap, small-cap or micro-cap stocks, and value or growth stocks. The difference between domestic and international is clear - domestic stocks are from American companies, international stocks are from everywhere else. International is sometimes broken down further into Asia, Europe, etc. Cap size labels refer to the size of the company that the stock is from - "large-cap" refers to stocks from big companies, "micro-cap" refers to stocks from really small companies. Growth and value are slightly more complicated. Growth stocks are stocks from companies that usually generate high earnings, and are therefore priced a little higher than other similar companies. They tend to be from established companies and are a little more stable than value stocks. Value stocks are from companies that are either not well established or are somewhat unstable, and are usually priced a little lower than stocks from similar companies. They are more volatile, but they have excellent potential in the long-term because of their lower purchase prices. Pretty much any stock will have a label from each of these categories. For instance, if the stock in question is from a big, well-established American company, then it's a large-cap domestic growth stock. If it's from a small, European start-up company, it's a small-cap international value stock.

The term "fixed income" is often used to describe bonds, but it really means any investment that yields a fixed interest rate or regular return. Therefore, things like CDs and even savings accounts can be considered part of this asset class. Bonds can be broken down further into short term (less than one year), medium term (one to ten years), or long term (more than ten years). There are also many different varieties of bonds (fixed rate, floating rate, high yield, etc.), which allow investors to customize the bond portion of their portfolio just as much as they do the stock portion. While bonds are generally considered "safe" investments, their safety depends on the financial health of the issuer. With higher risk comes the possibility for greater rewards, but obviously there is a greater possibility of losing money as well. If you still have questions about stocks and bonds, read "What are Stocks and Bonds?" for more information.

Now that you have a basic understanding of asset classes, you're ready for the next article in my series: "What is an Asset Allocation?", which will be linked to the series introduction article as soon as it becomes available. If you haven't opened an investment or retirement account yet, check out "IRAs vs. Mutual Funds: What's the Difference?" or "What is an Investment Account?", two other articles in this series.