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Asset Classes In A Portfolio – The Building Blocks Of Your Portfolio

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Introduction

 

 

In the previous lesson, we broke down the very basic terms and concepts you need to know in order to build on your investing knowledge. We briefly discussed the asset classes that were available to invest in and in this lesson we will be discussing asset classes in a portfolio, or more so, what kinds of assets you could use to build up your portfolio, along with their respective advantages and disadvantages.

 

But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.

Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.

 

Asset Classes in a Portfolio

 

 

Are you familiar with the phrase, “Don’t put all of your eggs in one basket.” What about this one? “Diverisfication of investments across asset classes is crucial to risk mitigation.”

You have probably heard the first one many, many times – the second one…..not so much.

But both are saying the same thing. You should avoid investing all that you have into one area – that way, if one or two “baskets” fall, you won’t lose all of your eggs.

So if eggs represent your money, baskets represent the various asset classes.

Asset classes are simply different types of investments like stocks, bonds, commodities, and cash.

Let’s start with cash.

Cash

 

 

Cash in a portfolio doesn’t mean a briefcase stuffed with 20s hidden under your bed. It means investments like short term certificates of deposits (CDs), money market accounts, and checking and savings accounts. Also, short term treasury bills often get lumped in with cash.

Basically, cash means non-stock investments that are liquid and readily accessible.

But cash isn’t without risks. If inflation rises, the buying power of cash gets clobbered. If your portfolio is only cash, you’ll have a hard time keeping up with rising prices. Let’s look at stocks next.

 

Stocks

 

Investors purchase stocks to obtain partial ownership in a company and share in that company’s profits. Stock
prices are subject to the volatile ups and downs of the stock market.

As far as generating consistent returns in your portfolio, historically, stocks have provided the highest returns.

On the flip side, severe losses can and do happen – and the risk to your portfolio is correspondingly.

 

 

If your investment portfolio is all stocks, you might easily outperform inflation, but market downturns could wreak havoc on your account balance. This leads us to bonds.

 Bonds

Bonds are IOUs issued by an entity like a government or a company and has the following features.

In exchange for your investment, the bond issuer pays interest over the length of the bond. When the bond matures, your initial investment is returned.

However, the government or company could default, which means it is unable to make the interest payments or return your principal.

Bonds generally have less risk than stocks and a bit more than cash. And the returns looks about the same – more than cash and less than stocks. And last but not least, there’s commodities.

Commodities

 

 

Investing in commodities is investing in the price of oil or gold or cowls of corn – essentially futures, a subcategory of derivatives as discussed in a previous lesson.

You’re making a bet that the price of a commodity are likely to we higher or lower in the future.

But because most of us don’t have room to store millions of barrels of oil and a herd of cows, most investors use futures contracts or shares of commodity funds to add this asset class to their portfolio.

While commodities tend to move out of sync with stocks, they’re sensitive to overall economic conditions and inflation. Holding a commodities only portfolio could be a wild ride.

There are other asset classes out there, but these are the four most common classes used to create diversified portfolios.

Each asset class moves to different market conditions for different reasons. The risks that each class is exposed to are different, as are the returns each one provides.

Ideally, when one asset class isn’t performing well, others are – and this protects your portfolio against those crashes that would “break all your eggs”.

 

Quick Recap

In Review……

Asset Classes

  • There are 4 main types of asset classes that were discussed in this lesson and are typically incorporated in investment portfolios
  1. Cash
  2. Stocks
  3. Bonds
  4. Derivatives (options, futures, forex, ect.)

Cash

  • Cash is investments like short term certificates of deposits (CDs), money market accounts, and checking and savings accounts. Also, short term treasury bills often get lumped in with cash
  • Basically, cash means non-stock investments that are liquid and readily accessible
  • But cash isn’t without risks. If inflation rises, the buying power of cash gets clobbered. If your portfolio is only cash, you’ll have a hard time keeping up with rising prices

Stocks

  • Investors purchase stocks to obtain partial ownership in a company and share in that company’s profits. Stock prices are subject to the volatile ups and downs of the stock market
  • As far as generating consistent returns in your portfolio, historically, stocks have provided the highest returns
  • If your investment portfolio is all stocks, you might easily outperform inflation, but market downturns could wreak havoc on your account balance

Bonds

  • Bonds are IOUs issued by an entity like a government or a company and has the following features.In exchange for your investment, the bond issuer pays interest over the length of the bond. When the bond matures, your initial investment is returned.
  • However, the government or company could default, which means it is unable to make the interest payments or return your principal
  • Bonds generally have less risk than stocks and a bit more than cash. And the returns looks about the same – more than cash and less than stocks

Commodities

  • Investing in commodities is investing in the price of oil or gold or cowls of corn – essentially futures, a subcategory of derivatives. You’re making a bet that the price of a commodity are likely to we higher or lower in the future
  • While commodities tend to move out of sync with stocks, they’re sensitive to overall economic conditions and inflation

 

 

This should give you a general layout of how to build an investment portfolio. If you can, you should strive to include just about a little of everything – that being stocks, bonds, mutual funds, ETFs, Certificates of Deposits (CDs), Futures, Binary Options, Annuities, ect. the more the better – but of course, everyone is different and everyone’s investment goals are different. Before you invest, it is best to first determine what your financial goals are and how much money you would ideally like to make over the course of several years – decades even – before you invest any capital into the stock market.

To clear any confusion, I know that I only discussed only one type of derivative – that being futures, but many investors also incorporate options and forex into their portfolios as well – although more people tend to trade derivative assets more so than any other asset class, mainly due to their leverage, volatility and high profit potential.

It is not necessary to incorporate these assets is your portfolio if you do not understand them. If you can not determine the price of heating oil over the course of two months – then you shouldn’t really invest in these assets. Derivatives can we lucrative if you know what you are doing but if you have no experience in these types of assets, you are probably better off investing in a treasury bond or a blue chip stock.

Not to worry, we will be discussing these types of assets classes – and many more in greater detail as you continue your investing education here at Invest In Wall Street.

I hope you have enjoyed this post and found the information to we quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.

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