Before we start reading about different asset classes, let’s understand the definition of ‘Asset Class’. “An Asset Class is a cluster of securities which have similar characteristics and works similarly in a marketplace and is regulated by laws and regulations. There are 3 main asset classes mainly equity or stocks, fixed income or bonds and cash equivalents or money market instruments”.
In simple terms, all the financial products or financial instruments belonging to an asset class possess characteristics:
- Amount of risk involved
- Expected Returns
- Liquidity factor
An investor should be well acquainted with different asset classes though not expertise in the asset class. One need not be any expert to be an investor, but a bare minimum requirement would be to have an idea about the asset class, risk appetite and returns potential. An asset allocation strategy in a portfolio would be a primary requirement for an investor because it would be imbecility to keep all the savings into one asset class because by doing this the risk would increase and return potential would go negligible for an investor.
As Warren Buffet quoted, “Do not put all eggs in one basket”, which means diversify your portfolio in such a way where your risk reduces and return potential increases. Asset Allocation is a very important tool to channelize your funds in such a way that your risk minimises and return potential increases.
For an investor, making money out of the investments would be his primary goal. Before investing in these asset classes, few things should be noted such as:
- Nature & characteristics of the different asset classes
- Risk & Return
- Comparison with other asset classes
- Investment horizon
- Market rate, Interest rate, Government policy, economic policy etc
- Taxation policy.
Your Investment should mainly depend on these 3 things. They are:
- Investment Horizon
- Investors finance goals
- Investors risk appetite
The Riskiness of the Asset:
Each asset class has its own idiosyncrasy. Looking at the table below, we have 5 different types of asset classes. Each asset class will deliver you different returns for the given period, and each asset class has a different amount of risk involved in it. From the below-given asset classes, equity and mutual funds are as the riskiest asset class of all but would give best returns amongst all. On the other hand, fixed income products and commodities have a low to moderate risk. And lastly, bank FD, PPF and all government bonds are risk-free investments, but the return potential is very low in these assets in comparison to equities and mutual funds.
Diversification of Asset class: