Asset Classes

Asset Classes — Sign up for different classes

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Asset Classes — Sign up for different classes

Most of us like to categorize and compartmentalize things based on certain characteristics and purposes. Attending a fancy dinner? Pull out the dress shoes. Going for a hike? Lace up the boots.

Asset allocation may have the greatest impact on your long-term investment performance.

Investments are similarly categorized into asset classes. An asset class is a way to categorize securities (or assets) that have similar risk and return characteristics, and perform similarly at any given time.

Drill down for diversification

The three main asset classes are:

  • Stocks - also known as equities
  • Bonds - also known as fixed income
  • Cash equivalents - money market and stable value investments

Within each of these main asset classes—particularly within stocks and bonds—there are numerous sub-asset classes. For example, stocks can be categorized into:

Bonds can also be categorized:

  • Corporate - Bonds issued by corporations as a way to raise money for business operations
  • Short-term - Bonds with durations of a few years or less
  • Long-term - Bonds with a duration of 15 years or longer
  • International - Bonds issued by foreign governments or corporations
  • Municipal - Bonds issued by state and local governments and their agencies
  • High-yield - Bonds with credit rating of BB or lower. Also called junk bonds.

Package it up with mutual funds

Mutual funds bundle together individual investments within a specific objective. There are over 7,500 mutual funds in the U.S., so finding one that specializes in the investment objective and risk tolerance that you and your investment professional feel are right should be easy.

Choice is good

Having choices is beneficial since each asset class and sub-asset class tends to perform different depending on
economic, cultural and political factors. This is why diversification across multiple asset classes is important.
Diversification increases the chance of having some of your money in whichever asset class is performing the best.
That will smooth out market ups and downs over the long term. In fact, asset allocation, or how you divide your
money among the major asset classes, has a greater impact on your portfolio’s total returns than the individual
investments you choose within each asset class.1

1 In 1986, Gary Brinson, L. Randolph Hood and Gilbert Beebower analyzed the returns of 91 large U.S. pension plans between 1974 and 1983. They concluded that asset allocation explained 90% of the variance in returns. That conclusion was confirmed by the same authors in 1991 after analyzing a larger database of returns. Roger Ibbotson and Paul Kaplan published a landmark study in 2001 titled "Does Asset Allocation Policy Explain 40%, 90%, or 100% of Performance?" The report confirmed that more than 90% of the variation in portfolio return is explained by asset allocation decisions. It is not the selection of individual stocks or bonds driving performance. It is the asset allocation that makes the difference in the longterm.

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