4 Asset Classes Everyone Should Know
It's hard to understand investing as a whole if you don't understand the four asset classes and the differences between them. If you mention investing around someone who doesn't invest, their first thoughts usually go to stocks and the stock market, but that's just one piece of the puzzle.
Asset classes are defined by investments that share similarities, such as how you purchase them, how they behave, and how they're regulated. The four asset classes are:
Cash and Cash Equivalents
When you hear about diversifying your portfolio, it's referring to owning a mix of different asset classes.
Stocks are a type of equity investment, and they represent ownership. When you buy shares in a company, you're buying ownership. For example, let's say a retail company named Mid 'n Fifths has 500,000 shares, and you buy 100,000 of them. At that point, you would own 20% of Mid 'n Fifths.
Even if you only buy one share of a huge company like Apple or Coca-Cola, which have millions of shares, you're still technically a part-owner. Your ownership percentage might be smaller than Spirit Airlines seats, but it'd be part ownership, nonetheless.
Buying equity in a company allows you to own part of the company without dealing with the day-to-day bullshit that comes with running a company. You can kick your feet up and [hopefully] reap the rewards of other folks' hard work. Kinda, sorta.
Some companies will pay their shareholders a portion of the profits in the form of a dividend, which is paid out quarterly. The dividend amount varies widely by company, but it's an amount paid per share you own. If you own 10 shares of Mid 'n Fifths and they pay out $2 dividends, you can expect $20 quarterly.
Bonds represent debt; when you buy an institution's bonds, you're loaning them money. In return, the institution—which can be a company, city, state, or federal government—agrees to pay you interest in the form of coupon payments, which are paid out every six months. These institutions basically hit you with the typical uncle, "c'mon, you know I'm good for it," line.
(Quick sidenote: "You know I'm good for it" is family code for "I'm not good for it.")
Bonds have predetermined lifespans, so you'll receive your interest payments every six months throughout the lifespan of the bond. Once the end date arrives (called the maturity date), you will receive the principal back.
For example, if you buy a $1,000 bond with a 10-year lifespan and an annual interest rate of 3%, you'll receive a $15 payment every six months ($1,000 * 3% = $30, split into two payments). Once 10 years are up, you'll receive your $1,000 back.
Bonds have a rating system that shows how likely they are to make their payments and pay you your money back. It's basically on a scale of "they're good for it" to "I wouldn't loan them the penny I just found on the ground."
Tangible assets are ones you can physically touch and see. Although stocks and bonds have monetary value, you can't physically touch them, so they're not considered tangible. Real estate is by far the most common tangible investment, but it's not the only one.
Livestock—like those chickens they keep feeding us with all those damn GMOs in them—are also a common type of tangible asset. Everybody eats, b. The same goes for gold. Like, real gold, not the middle-of-the-mall chains your local rapper from the crib be wearing.
Cash and Cash Equivalents
Cash is any money in the physical form of currency, such as bills and coins. Although you can physically see and touch currency, folks with too much time on their hands argue that they should be separated from other tangible assets because they're just certificates that represent value, but the currency in itself doesn't hold value. Either way, that money in your wallet, shoebox under the bed, underneath your mattress, or your safe is considered an asset.
Cash equivalents can include uncashed checks, checking and savings accounts, or any short-term investment with a maturity date of 90 days or less.
You never want one asset in your portfolio to be carrying all the weight like LeBron and those Cleveland Cavaliers teams before he left for Miami. You want it to be that Miami Heat team once LeBron arrived. Make sure some assets are playing their D. Wade and Chris Bosh roles. This allows you to take advantage of all their strengths and save you if shit hits the fan.