Standard Asset Classes

Investing is not a risky maneuver of luck or probability, but more about financial education, positioning, and utilizing a long term time horizon. Below are three standard asset classes that any serious investor should know about.

1. Equities

Domestic equity represents ownership of a piece of a US- based corporation in the form of company stock. Shareholders are entitled to a dividend if the company pays one. In general, domestic equities are a liquid and rather efficient asset class that is heavily researched by third parties. Domestic equities are further broken down into subcategories.

  • Large-cap equities are the largest 5% of domestic companies in terms of market value.
  • Mid-cap equities are the next largest 15% of domestic companies in terms of capitalization.
  • Small-cap equities are the remaining 80% of companies in terms of capitalization.

The next categories are stocks based on investment approach: Value investing vs Growth

  • Value stocks are usually large cap stocks with low P/E ratios, but generally a stock with good fundamentals relative to its price (i.e. dividends, earnings, sales, etc.) and thus considered attractive to a value investor.
  • Growth stocks include company stock whose earnings are expected to grow at an above-average rate relative to the market.

International equities represents ownership in companies based outside of the US and are broken down by country classification.

  • Developed-market equities are equities from developed countries. Strategies targeting international developed markets typically provide similar expected returns as domestic equity investments; however, they provide portfolio diversification. Developed economies are comparable to the U.S. in terms of economic infrastructure and have common drivers of economic performance. However, markets in different regions can respond to different economic forces, which causes uncorrelated and differentiated returns.
  • Emerging-market equities are equities from the emerging country classification, and can provide higher expected returns than international developed equities, but with higher levels of risk. Emerging market countries are becoming more popular and competitive than ever before and are housing a number of world-class companies.
  • Frontier market equities are equities from the frontier market countries and generally have less advanced capital markets from the developing world. Frontier markets are countries with investable stock markets that are less established than those in the emerging markets.

So now that I know about the different equity asset classes, how do I invest in Equities? Below are investment vehicles under the equities asset class:

A stock is an ownership share in a corporation (equity) and can be purchased from a discount broker or directly from the company.

Mutual funds are baskets of equities to achieve diversification and are either tied to an index, passively managed, or actively managed. There is a fee charged by the company issuing out the mutual fund.

  • Index fund attempts to mimic the performance of a specific market index, such as the S&P 500® Index or the Wilshire 5000 Index.
  • Actively managed fund are funds in which professional managers choose what they believe are the best investment opportunities, given a fund’s strategy, with the goal of outperforming a specific benchmark.
  • Stock (or equity) fund invest in stocks based upon different categories and characteristics. These can range on whether the equity fund is focused on growth, income, or international exposure.

Exchange Traded Funds are a single investment that generally holds a basket of securities (such as stocks, bonds) and trades like a stock. It can offer built-in diversification similar to an index mutual fund, but it differs in that you can buy or sell shares anytime during the trading day.

2. Fixed Income

Debt that will be payed back to the investor on a set maturity date along with periodic interest payments usually twice a year. Bond prices and interest rates have an inverse relationship – when interest rates fall, bond prices rise, and when interest rates rise, bond prices fall.

US fixed income

  • Government bond funds invest primarily in bonds issued or guaranteed by the U.S. government. Government bonds include Treasury bonds and treasury bills as well as mortgage- and other asset-backed securities backed on the government. These funds may also invest in bonds issued by government-sponsored enterprises that are not explicitly backed by the U.S. government.
  • Mortgage-backed bond funds are bond funds that invest in securities backed by pools of mortgages. These securities can be issued by government sponsored enterprises or by a bank or other financial institution.
  • High-yield bond funds are taxable funds that invest primarily in lower-credit-quality securities. These can potentially provide income and total returns higher than investment-grade bond funds.
  • Municipal bond funds are bundles of bonds issued by municipalities. Investors in higher tax brackets who want to generate income in a tax-efficient way may benefit from municipal bond funds. While these funds may offer lower yields, the income generated by the bonds in the portfolio is typically free from federal taxes.
  • TIPS or Treasury Inflation Protected Securities allow an investor to keep up with the uncertainty of inflation. The face value of these bonds adjusts to keep pace with the Consumer Price Index (CPI).
  • Corporate bond funds are funds that consist of corporate bonds. Corporations issue bonds to expand, modernize, cover expenses and finance other activities. The yield and risk are generally higher than most government and municipal bond funds. Rating agencies help you assess the credit risk by rating the bonds according to each company’s financial profile. Income from corporate bonds is fully taxable.
  • Broad market bond funds are bond funds that are diversified across many different types of bonds including those issued by the U.S. government, government agencies, corporations, and bonds backed by mortgages.

International bonds

  • Developed-market government bond funds are funds that invest in the bonds issued by countries with developed economies, which usually have a more established history of repayment. These funds are generally considered to have the lowest risk profile of the group.
  • Emerging-market government bond funds are funds that typically invest 65% of assets in bonds issued by countries with smaller, less developed economies. Emerging market funds may have additional or greater risks than other international bond funds.
  • Developed-market corporate bond funds are funds that invest in bonds issued by companies headquartered in countries with more established economies. Depending on the fund, the credit quality of the bonds may vary, which will have an impact on the fund’s risk profile.
  • Emerging-market corporate bond funds are funds that invest in bonds issued by companies headquartered in smaller countries whose economies are still developing. While these types of bonds generally represent the highest risk of any international bond, the risk profile of each fund will vary according to the credit quality of the individual bonds held by that fund.

How Do I invest in Fixed Income? Below are investment vehicles from fixed income asset class:

Bond funds
Bond funds are a bundle of individual bonds which are usually managed into bond ladders (with a cascade of maturity dates). Many make periodic dividend payments based on the interest paid by the bonds held in the fund.

Fixed income ETFs
Fixed income ETF’s are similar to the usual bond fund, but the only difference is that ETFs can trade as a single unit throughout the day.

Individual bonds
An investor may purchase individual bonds, but with a par value of $1,000 for one bond and the relative lack of liquidity from buy and selling odd lot bonds in small sizes, bond funds offer a better alternative for those investors with little capital but who want to diversify their fixed income holdings.

Fixed Income Annuities
A fixed income annuity provides an investor with guaranteed income by turning a portion of investors’ savings into a stream of income payments for the rest of an investors’ life or a set period of time.

Structured Products
Structured products offer investors the potential to earn returns tied to the performance of an index or basket of securities. Rates of return vary and are generally paid at maturity, along with the face amount of the investment, subject to the credit risk of the issuer.

3. Real Assets

Real estate is land plus anything permanently fixed to it, including buildings, sheds and other items attached to the structure. Although, media often refers to the “real estate market” from the perspective of residential living, real estate can be grouped into three broad categories based on its use: residential, commercial and industrial.

Commodities are most often used as inputs in the production of other goods or services, and can be used as investments as prices of such can increase or decrease. Examples of a commodity are gold, silver, oil, coca beans, ect.  The quality of a given commodity may differ slightly, but it is essentially uniform across producers.

Private equity and venture capital, equity capital that is not quoted on a public exchange. Private equity consists of investors and funds that make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity. Capital for private equity is raised from retail and institutional investors, and can be used to fund new technologies, expand working capital within an owned company, make acquisitions, or strengthen a balance sheet.
Cash Investments are short-term obligations, usually fewer than 90 days, that provide a return in the form of interest payments. Cash investments generally offer a low return compared to other investments.

How Do I invest with Real Assets? Below are investment vehicles under the Real Asset class: 

Basic rental properties
An investor can buy a property and rent it out to a tenant and receive rent. After mortgage, taxes, insurance, and maintenance, the net amount is profit to the owner.

Real Estate Investment Groups
Real estate investment groups are structured as small mutual funds for rental properties. A company will buy or build a set of apartment blocks or condos and then allow investors to buy them through the company, thus joining the group. A single investor can own one or multiple units of self-contained living space, but the company operating the investment group collectively manages all the units, taking care of maintenance, advertising vacant units and interviewing tenants.

A real estate investment trust (REIT) is created when a corporation (or trust) uses investors’ money to purchase and operate income properties. REITs are bought and sold on the major exchanges, just like any other stock. A corporation must pay out 90% of its taxable profits in the form of dividends, to keep its status as an REIT.

Commodity futures
An agreement to buy or sell a set amount of a commodity at a predetermined price and date. Buyers use these to avoid the risks associated with the price fluctuations of the product or raw material, while sellers try to lock in a price for their products.

Commodity ETF
Exchange-traded funds that invest in physical commodities such as agricultural goods, natural resources and precious metals. A commodity ETF may be focused on a single commodity and hold it in physical storage or may invest in futures contracts. Other commodity ETFs look to track the performance of a commodity index that includes dozens of individual commodities through a combination of physical storage and derivatives positions.

Commodity mutual funds
Commodity funds invest in a variety of formats. The potential strategies include investing in physical commodities, holding commodity-linked derivative instruments, investing in companies that operate in commodity-related fields or a combination of various formats.

Private Equity ETF
An investor can purchase shares of an ETF that tracks an index of publicly traded companies that invest in private equities.

Certificate of Deposits
When investing in a CD, you deposit a fixed sum of money for a specific amount of time, after which you get back your principal plus interest.

Money Market Funds
Money market funds are mutual funds that hold a portfolio of high-quality, short-term investments. Shares must be actively bought or sold just like other mutual funds.

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