In this article we’ll cover…

• Definitions and explanations of the primary asset classes

• Explanation of how they play a role in your portfolio

• How to figure out how much to invest in any given asset class

• How to invest in each asset class (direct, ETFs, mutual funds)

• spicy asset classes like venture capital, IPOs, etc, what an accredited investor is, are there ways to get involved in these without being accredited?

Pretty much anything you can invest in can fall under one asset class or another. Even obscure investments, like baseball trading cards, will fit into an asset class (tangible alternative assets, in this case). It’s important to understand asset classes, as investing across asset classes greatly helps in reducing risk.

The Different Asset Classes

An asset class is a group of securities that have similar behavior and behave similarly in the market. Historically, there have been three asset classes: equities, fixed-income and debt, and cash and cash-equivalents. However, recently, financial professionals have generally agreed on adding another: real assets.

Equities represent ownership. Stocks and funds are considered equities, as you have a stake, or “equity,” in whatever entity you purchased. For example, if a company is worth $1,000,000 and you purchase $1,000 in stock of the company, then you own 1% of the company. You can profit by owning equities through the rise of the stock’s price or through dividends. Read our article here on dividends and the risk/return associated with different types of companies. Equities are a slight exception to the definition of an asset class, because the behavior of an up-and-coming growth company can vary greatly from a blue-chip stock. Since they offer no guaranteed returns, equities are generally considered the riskiest asset class, but they are also the asset class with the highest historical returns over time.

Fixed-income securities are assets that pay a fixed interest rate back to investors. The interest payments are usually given on a semi-annual basis and the principal is returned upon maturity, with the most common security in this asset class being bonds. Fixed-income securities aren’t seen as especially risky, since they are usually purchased from governments or investment grade companies. Of course, if you buy a bond from a company and it goes bankrupt, they have no obligation to give you back interest and principal (you can still trade them with other investors, but they often hold very little value).

Assets that qualify as cash and can be quickly liquidated (turned into cash) fall into the cash and cash equivalents category. Obviously, cash is included, and Treasury bills and commercial paper can also be considered cash-like assets. These assets provide little to no returns, but they also have little to no risk.

Real assets are tangible things, such as a watch or gold, with the most common form of real assets being real estate and commodities (raw materials like gold, oil, wheat, etc.). Real assets can appreciate in value, but they may need to be sold to get those returns. Furthermore, if you own a property and charge rent, you will also realize gains in that way. Commodities change in value based on supply and demand, so the market will have a strong impact on the value of these real assets. Real estate prices can also undergo price changes reflecting the current economic climate.

How do Asset Classes Fit into my Portfolio?

Having a mix of asset classes in your portfolio is considered a balanced portfolio and it is recommended by financial professionals. This is a form of diversification, and it decreases risk in your portfolio by having safer asset classes makeup for the volatile nature of others.

The following table will show different types of investment styles for equities, fixed income securities, and cash and cash equivalents as a percentage of your portfolio. Real assets and alternative investments are trickier to fit into this model, as they are being studied more only recently. If you are interested in adding them to your portfolio, 5-10% seems to be a general rule of thumb, but you should discuss it with your financial advisor before making that decision.

How to Invest in Each Asset Class?

Equities can be bought and sold on major stock exchanges, like the NYSE. You used to have to go through a broker, but apps like Robinhood allow you to jump over that barrier. Read our article here on the pros and cons of some major brokerages. There are many forms of equities that you can buy, whether it be direct stock, an ETF, a mutual fund, etc. Each investment vehicle offers their own pros and cons, which is expanded upon in our article here.

Fixed-income securities can usually be bought through your investment account. The most common way to invest in fixed income securities is to buy bonds. Furthermore, most brokers offer their customers direct access to fixed-income funds and ETFs.

There are many forms of cash equivalents and a lot of them can be bought through your broker. For example, commercial paper is sold by many brokers, but it is typically traded in increments of $100,000 or more, making them an unreasonable investment for most. You can also invest in money-market funds through your broker, making them the go to source for these sorts of investments.

Real assets, on the other hand, are a little different. Since they are often tangible assets, they can be bought and sold on most marketplaces. For example, if you’re looking to buy a home, there are a plethora of websites and real estate services available. When it comes to commodities, you can either purchase their physical form, or you can purchase portions of a fund that tracks their prices, effectively investing in them.

High-Risk, High-Reward Asset Classes

If you’re feeling especially risky, you can look into some of the “spicier” asset classes.

Venture capital is a form of private equity in which investors (typically very wealthy individuals or large banks) provide money to startups and small businesses with high potential for growth in exchange for equity in the company. If the company does well, the investors will reap extreme rewards, but, at the same time, they can end up losing their entire investment if the company fails.

An initial public offering (IPO) is the process where a private company first gets listed on a public stock exchange. There is typically much less information on an IPO’ing company, and investors are making decisions with many unknown variables. Because of this, the IPO price often does not reflect the real price, and there is extreme volatility following an IPO.

If you’ve been on the Internet at all in the past couple of years, chances are you’ve heard about cryptocurrencies. While many disagree on whether or not they are a good investment, one thing is undeniable: they come with a great amount of risk. Since there isn’t much practical infrastructure built for them yet, people buy in with their potential in mind. However, if attitudes shift and they become seen as obsolete, their value will quickly plummet. For that reason, they come with a great deal of risk, but, if you believe in their potential, they can also offer huge returns.

In general, most people without much financial experience should stay away from these types of investments, and there are some that you aren’t allowed to buy without certifications. Only accredited investors are allowed to invest in unregulated securities, like an early-stage startup. Some other investments that only accredited investors can make are venture capital, private equity, hedge funds, and angel investments.

In order to be an accredited investor, there are three possible qualifications.

1. Your annual income is either $200,000 alone, or $300,000 combined with your spouse.

2. You’re a “knowledgeable employee” of certain investment funds or have a valid Series 7, 65, or 82 license.

3. You have a net worth of $1 million or more, excluding your primary residence.

One relatively new way non-accredited investors can invest in these securities is through crowdfunding platforms such as StartEngine or WeFunder that allow investors of any income level to invest in start-ups. However, these vehicles are much riskier and less liquid than if you were an accredited investor. You can also try investing in a hedge fund, but it is much easier said than done. First, you usually need to know someone and you’ll be screened thoroughly. Furthermore, money invested with a hedge fund is much less liquid and minimums can be very high.

While the potential of investing in the next Facebook can be very alluring, it is very rare that an investor actually finds that “unicorn” company. When dealing with high risk investments such as these, only invest the money that you are willing to lose.