Understanding the different asset classes is essential to achieving portfolio diversification—a must-have for long-term portfolio performance and something I’ve witnessed the need for firsthand.
As the son of immigrants, I grew up watching my parents pursue the American Dream. They started a Chinese-American restaurant, and I worked alongside them to grow the business. During this experience, my understanding of assets was greatly influenced by hardship and culture. That hardship stemmed from my parents having lived through World War II and the communist revolution in China, and our cultural lens was “traditional Chinese.” This meant cash was king, and my family believed cash was best spent on physical gold in the form of coins, jewelry, and a house. Any extra cash was put into the stock market.
My understanding of assets was further influenced by experience with volatility: multiple cycles of recession and economic expansion punctuated by two back-to-back financial crises—the worst since the Great Depression. These crises caused me to pursue diversifying my assets to ensure that I had a balanced portfolio tailored to my needs, especially my retirement needs.
While everyone’s financial needs are unique, we can all benefit from a foundational understanding of asset classes and diversification strategies. You may also wish to consult with a financial advisor before making any portfolio adjustments.
What Is an Asset Class?
An asset class is a group of similar kinds of assets. All asset classes are geared toward saving for short-term and long-term goals, such as retirement.
Acquiring assets in different asset classes may help you diversify your portfolio. As there may be little direct correlation between different classes, including multiple asset classes in your portfolio may help offset the ups and downs experienced by each in the long term.
What Are the Different Asset Classes?
Traditional asset classes include stocks, bonds, and cash or cash equivalents. Meanwhile, alternative asset classes encompass real estate, commodities, futures, and precious metals.
When someone typically buys a share of a stock (also referred to as an equity), they receive a stake in a company through a stock market like the New York Stock Exchange or Nasdaq stock exchange.
Stocks offer the opportunity to earn a potentially high return on your money and own a piece of a business. However, these equities come with risk. No one can predict how much the price of a share of stock will rise or fall.
“A good rule of thumb is to scale back on the percentage of stocks and increase your high-quality bonds as you age, in order to be better protected from potential market downturns,” according to Investopedia. “For example, a 30-year-old [person] would hold 70% in stocks and 30% in bonds, while a 60-year-old would have 40% in stocks and 60% in bonds.”
Also called fixed-income instruments, bonds enable companies or governments to borrow money in exchange for a fixed rate of return. Over time, the market value of a bond can fluctuate.
Bonds usually come with lower risk than equities and so may contribute to a balanced portfolio. However, they generally provide lower returns than equities and are sensitive to changes in interest rates.
As a general rule, The Balance recommends that someone hold 50% of their portfolio assets in bonds and 50% of their assets in stocks as long as they believe they have more than 15 years to live. However, this strategy does not take full advantage of the diversification benefits offered by alternative assets.
Cash and Cash Equivalents
Cash or cash equivalents make up another asset class.
The key benefits of cash or cash equivalents, such as money market funds, are that these involve lower risk compared to equities and are easily accessible. But because cash is accompanied by lower risk, it may provide a low return—in fact, inflation can eat away at the value of cash.
According to The Balance, a more aggressive stance would have someone keep at least 5% of their portfolio in cash, while a more conservative approach would put that number at 10 to 20%.
The real estate category includes commercial property, residential property, and undeveloped land. Real estate can protect against inflation and see sizable increases over time. On the other hand, owning and maintaining property can be a time-consuming, long-haul way of building wealth, and there’s always a chance that property may depreciate over time.
Daniel Kern, chief investment officer at TFC Financial Management in Boston, suggests a 5 to 10% real estate allocation across your overall portfolio. By contrast, Ken Johnson, a real estate economist at Florida Atlantic University, puts that figure at 50%.
Commodities include assets like oil, natural gas, and wheat. They can offer portfolio diversification, protection against inflation, and upward potential. However, commodities also come with price fluctuations and risk.
“Allocating some of your portfolio to commodities is recommended by many experts as it is seen as a diversifier asset class,” Investopedia says.
Futures are financial contracts that commit someone to buying or selling an asset like oil or wheat in the future at a set date and price. Regardless of the current market price at the time of purchase or sale, a future’s price is locked in at the predetermined rate. While futures are highly liquid and can produce a healthy return, they also bring uncertainty and volatility.
Financial services provider Morgan Stanley suggests that futures be part of a 10 to 24% allocation to alternative assets.
Forbes points out that precious metals make up “one of the most useful alternative asset classes” for those seeking to reduce exposure to volatility in the stock market. Typically, consumers buy precious metals in the form of gold, silver, platinum, and palladium bullion, bars, and certified coins.
“Precious metals such as gold and silver are physically scarce, chemically unique, and useful for industrial applications. For these reasons, they’re an excellent long-term store of [wealth],” Forbes reports.
Aside from being a long-term store of wealth, precious metals include the following benefits:
- Intrinsic worth
- A history of use as a hedge against inflation
- Significant liquidity
- Portfolio diversification
- Simplicity of purchasing
One analyst at abrdn (formerly Aberdeen Standard) generally suggests allocating 10% of a portfolio to precious metals. In other cases, experts recommend allocating as much as 15% of a portfolio to precious metals. I feel that if you’re buying gold as an insurance policy to soften what might happen to a dollar-focused portfolio, then you would not want to buy an insurance policy larger than what you’re trying to insure.
Diversify with Help from U.S. Money Reserve.
With help from U.S. Money Reserve, you can learn more about the precious metals asset class. As America’s Gold Authority®, U.S. Money Reserve can provide you with the resources and support you need to make wise decisions when diversifying your portfolio.