Asset classes are defined as a group of investments that share similar characteristics and behave similarly in the marketplace. The three major asset classes are equities (stocks), fixed income (bonds), and cash equivalents (money market instruments). Other common asset classes include real estate, commodities, and collectibles.
Investors generally believe that different asset classes will perform differently over time, and that by diversifying their portfolio across several asset classes they can minimize risk while still achieving their desired return. For example, stocks have historically outperformed bonds over the long term, but they are also more volatile in the short term. By including both asset classes in a portfolio, investors can theoretically achieve both growth and stability.
The specific mix of asset classes that an investor chooses will depend on their individual goals and risk tolerance. For example, a retiree who is relying on their portfolio for income will likely have a different asset allocation than someone who is still working and saving for retirement.
Asset allocation is not a static process, but should be reviewed and rebalanced on a regular basis to ensure that it still aligns with the investor’s goals. For example, as an investor gets closer to retirement they may want to shift some of their assets from stocks to bonds in order to reduce volatility.
It’s important to remember that there is no one-size-fits-all asset allocation; the right mix of assets for one person may not be appropriate for another. When making investment decisions, it’s important to work with a financial advisor who can help you develop an asset allocation strategy that is tailored to your individual needs.