What are asset classes?
Asset classes are groups of similar investments that generally behave the same way under market conditions. Investments are grouped into classes according to features they have in common. Generally, these include their level of risk and potential return, their liquidity—or how easily they can be converted to cash—and often the rules and regulations they’re governed by.
Being able to identify investments by asset class makes it easier to pick a mix of products that will give you the level of risk and return that suits you and your goals.
What are the main asset classes?
You might come across different names for asset classes, but the most common ones you’ll see in a retirement plan are guaranteed, fixed income, and equities. Each includes some risk and offers a possible return on your investment.
Let’s look at each asset class
This is considered the safest asset class, as the money you invest and the return you get are guaranteed at maturity. Examples of guaranteed investments are guaranteed interest accounts (GIA) and guaranteed investment certificates (GIC), where you invest for a fixed term ranging from a few months to several years.
- How they make money—They earn interest at a fixed rate over the length of the term, and their value at maturity is guaranteed.
- Risk and return—There’s no risk if you keep them to maturity, but if you cash them out before that, you won’t get the full value of the return. You might even lose money on a GIA due to the market value adjustment. Interest rates vary depending on the length of the term, but returns are usually low over the long term relative to other asset classes.
- How they can work in your investment strategy—Because they’re guaranteed, they can be a safe investment, especially during a volatile market.
Fixed-income investments are in fact loans you make to a company or government agency for a certain term. Bonds and treasury bills are good examples of fixed-income investments.
- How they make money—In return for your loan, you get regular interest payments over the term of that loan. At maturity, you get back the money you invested.
- Risk and return—Some fixed-income products, such as government bonds and treasury bills, guarantee your main investment and your return. Others, such as corporate bonds, can carry more risk, depending on their credit rating. Changes in interest rates can also reduce or increase your returns on bonds. But while they’re not guaranteed and have more risk than guaranteed investments, they offer more potential return and can provide a regular, predictable income.
- How they can work in your investment strategy—They offer a steady income while protecting your initial investment.
Equities are shares of publicly traded companies that you can buy. They go up or down in value based on the company’s success or market conditions. Equities are also known as stocks.
- How they make money—The shares you own go up in value when the company’s stock price goes up. You may also get dividends—part of the earnings that the company distributes to its shareholders.
- Risk and return—Equities come with the most risk, as no part of your investment is guaranteed. But they also come with the highest potential for returns over the long term.
- How they can work in your investment strategy—In a long-term strategy, such as saving for retirement, equities can give you the investment growth you need to help you reach your goals.
How do asset classes work together?
As you can see, each asset class behaves differently, makes money differently, and carries a different level of risk. It’s why investment specialists generally recommend diversifying your investments by spreading your money across different asset classes and in different products within each asset class. This strategy is called asset allocation.
Your asset allocation will depend on many things—what you’re saving for, how much you’re investing, when you want to reach your goal, and how much risk you can tolerate.
But to make it simple, asset allocation should help you get the growth you need to reach your savings goals while helping you weather the occasional market downturn.
Now that you understand how asset classes can work in your strategy, talk to your financial advisor. Together, you can review your asset allocation and make sure it aligns with your goals.
The commentary in this publication is for general information only and should not be considered legal, financial, or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation.