Asset Class Primer - Breakdown of Major Types of Investments

When you think of assets, you may first think of your fixed possessions, like your home or condo, car or other valuable items. Or hey, maybe you're thinking about your runner's legs or squat-rack sculpted tush! While all of these are important to LMF4HMW readers, there's another type of asset with which you should have familiarity: financial asset classes.

I know this topics sounds pretty boring, but today's post is actually quite zippy! So I've chosen a similar wine, Albarino, which will make asset classes slide right down. Albarino is primarily from Rias Baixas, Spain, and is a crisp, lemony, peachy and often has almond characteristics. Perfect for summer weather and seafood!

There are three primary forms of assets -- stocks, bonds and cash. Stocks, or "equities" as they're referred to in the financial world, represent fractional ownership in a publicly-traded corporation. A share of stock is a claim to the company's assets or earnings, and the number of shares represents the fraction of ownership.

Bonds, or "fixed income" debt investments, are basically I.O.U.s from a company or government that has borrowed money from an individual or institution. Over a set period of time, the borrower will pay a set interest rate, usually semi-annually, and return the amount invested, or "principal" at maturity). There are many different types of bonds -- have you ever heard of zeros (those that trade at a discount and return more than the sum invested), munis (local or state issuance that often have tax advantages), or junk bonds (riskier investments with higher potential return)?

A lot of people think of bonds as "safer" than stocks, but this isn't necessarily true. Risk is a bigger topic -- that of my next posting, and is determined given inputs and desired outputs like time horizon, goals, etc. Something that's often harder to keep straight is that bonds and interest rates have an inverse relationship: when interest rates or yields increase, the value of the existing bond held decreases. This is because newer issuances are offering higher interest rates and those holding lower interest-rate bonds are receiving less remuneration for lending money.

Finally, the third major asset class is cash. Good old, cold, hard cash, which in this case includes highly liquid (or easily cashed out of) money market instruments -- savings accounts, Treasury bills, certificates of deposit, etc.

Congratulations! You should now have a solid understanding of the three major asset classes. Next week's post will cover asset allocation.