Categories of Assets - Asset Class Definition

Securities belong to different asset categories. The most common different asset categories are bonds, stocks, and cash equivalents.

This article will discuss those three major asset classes: stocks, bonds, and cash/cash equivalents.

• Stocks

  Among the general asset categories, stocks are generally the riskiest investments. They are also the investments that will give you maximum returns for your money.

  Stocks ownership implies ownership interest in the company that issued the stock. Thus, the potential returns from a stock investment depend largely on how well the company that offered the stock performs. If the company goes bankrupt because of bad business decisions, its stock will also lose much of its value. If a company does very well, however, the value of its stock is likely to rise as well.

• Bonds

  Investing in bonds means lending money to the company or the entity that issued these bonds. Bond investment does not entail ownership interests in the bond issuer.

  Bonds are considered to be less risky than stocks. A debt is a financial obligation that cannot be easily discharged. In fact, when a company goes bankrupt, its bondholders receive their share of the company's net assets before stockholders can even hope to get their money back. Bonds are instruments of debt whereas stocks are instruments of ownership - and in bankrupt companies, creditors are paid before owners are.

  Bonds are also less risky than stocks because their returns do not rely on how much profit the company posts in a year. Stocks, on the other hand, earn high when the company is doing well, but they earn low when the opposite is true.

  Even if bonds entail a relatively lower level of risk, you should still not invest blindly in any stock. Bondholders may be paid sooner than stockholders, but if the company that goes bankrupt has not enough assets, both are likely to remain unpaid.

  Since bond investment entails less risk, they also give a lower rate of return when compared to the riskier stock investment.

  There are bonds, however, that offer a higher rate of return than is normal for the asset category. These bonds are known as junk bonds or bonds issued by companies that do not meet the standards of creditworthiness. Investing in junk bonds, therefore, comes with great risks; as such, they also offer high rates of return.

  Investing in junk bonds is as risky and as potentially rewarding as investing in stocks. If a junk bond issuer does well, its bondholders stand to make a lot of money. If a junk bond issuer goes under, however, its bondholders are probably not going to get paid.

• Cash and cash equivalents

  Cash and cash equivalents have the lowest risk among the most common asset categories. Examples of cash or cash equivalents are treasury bills, money market funds, certificates of deposit, savings deposits, money market deposit accounts, etc.

  Cash or cash equivalents are some of the safest assets available. However, they also offer the lowest rate of returns. The risk of investing in cash and cash equivalent comes not so much from market fluctuations but from their tendency to lose value over time due to inflation.

When constructing your investment portfolio you may select any of these classes of assets or make combinations out of them.

In order to benefit from the advantages offered by each asset class you should try to include them all in your investment portfolio. In this way you will achieve greater levels of diversification within your portfolio and increase your chances of alleviating the negative impacts of a market down turn.

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