Your money goes into different places or things when you choose to save or invest and they are called Asset Classes. If you didn’t know, all your investments are classified, and it’s better if you keep that information as classified!
Asset Classification or Asset classes:
Let’s say you have invested in a Fixed Deposit and PPF. Both are different financial instruments, but deep down both are secure products, with minimal risk and fixed returns which are predefined. The similarity in their characteristics is because they both belong to “Fixed Income” asset class.
Similarly, an equity mutual fund or direct stocks are different financial instruments, but both are highly volatile instruments, on the characteristics of risk and returns. This is because they both belong to the asset class called “Equity”.
To understand now, asset class is a segmentation of the financial products based on their similarity in characteristics like liquidity, risk, returns etc.
The 5 classes
The common 5 classes of assets:
- Fixed Income
- Real Estate
Any financial product will fit in one of these and each of these classes exhibit a unique set of characteristics of their own.
Asset Class #1 – FIXED INCOME
To begin with the most common, which is “Fixed Income”, is an asset class which refers to the class of financial products where there is little/no risk and the returns are predefined.
This is very similar to lending with predefined time and interest with assurance. Having a fixed deposit means investment but in reality is lending to the bank with an agreed interest and date.
Fixed Deposits loses to inflation
Many do not realize that on a 8-9% return on fixed deposits, it’s the pre-tax return and as Fixed deposits are taxable like any other debt instrument, once you pay the tax on the returns, the post tax returns are only in range of 6-7% and again on calculating the inflation of 8-10%, you are actually getting a negative return on your investments.
Minimal Risk in Fixed Income Asset class
This asset class is basically for people who seek assurity without any risks and with an easy understanding. Though FD’s, PPF, NSC, Govt Bonds etc are the options to protect your money over a period of time, they succumb to inflation and do not help in growing your money.
Asset Class #2 – Equity
Equity means ownership
Equity relates to ownership, so when you invest in equity, it means that you have bought ownership into a business. For example, when you buy stocks of L&T or HDFC, you become a small owner of that business.
Works out on a long term
So it is very obvious that being a proportionate owner, you travel along with that company on both its good and bad times which reflects in the rise and dip in the stock price. People who have made it really big are either the ones that opened on their own or invested in to one and held onto it for a very long term.
Due to its highly volatile nature, people are usually scared of mutual funds investment or investing into direct stocks, but they are the real wealth builders for any investors. You could choose from various asset management companies which have a proven track record for building wealth for its investors.
Asset Class #3 – Real Estate
Real estate refers to owning residential, commercial, retail or industrial spaces and is used to generate income or create wealth from its appreciation.
There is an inclination over the last 2 decades to invest in this asset class either in the form of entire ownership or in the form of REIT’s owing to the never ending demand for infrastructure. A small similarity from Equity is that holding on to it over a longer period of time is when one can see good appreciation in returns and when it comes to liquidity, it is not the easy. Risks are average but periodical investments or smaller ticket sizes are the practical difficulties.
Asset Class #4 – Commodities
Commodities refer to physical goods or products like Gold, Silver, Copper, Rice, and Oil etc under this asset class, where the price of these products depend on the demand and supply in the market.
This means “Trading”; not investing
Commodities are not for investing for long term, but mainly for trading, where by watching cautiously how the market cycles and predict its demand and supply moves, you would be making a profit or loss.
Returns are highly volatile and each commodity has its characteristics of demand ratio and market dynamics.
Commodities like Gold or Silver can be invested in for a very long time whereas mostly other commodities can only be traded for short term as a feasible option.
Asset Class #5 – Cash
Cash relates to physical cash, balances in accounts, liquid mutual funds etc. Holding to cash gives the power to buy anything, anytime, is secure with no risks but it doesn’t help you in growing your money. It doesn’t surprise to see when people have lakhs of money in a savings account doing no good but just for one reason about risk and security. The one issue with having cash is that this too succumbs to inflation and with a 4% return in bank account, you should seriously consider about this as an investor.
In a nutshell:
To summarize, this article would have given you the basic understanding on the risks, returns, liquidity and investment patterns based on which you can identify the financial product’s asset class, based on which you could now direct your investments with a stronger knowledge of where exactly your investment trickles down to.