Simple asset class definition
An asset class is a group of similar types of investments based on what they invest in or how they earn a return.
By choosing different asset classes you can diversify your investments. Because different types of investments react uniquely to market changes, the strength of 1 type of investment can help balance any weakness in another. This reduces your overall investment risk.
The main asset classes
Equities, also known as stocks, are ownership shares of a publicly owned company.
When you invest in equities, you may earn a return from a dividend which a company may pay shareholders when that company does well. You may also earn money by selling equities for a higher price than you paid for them.
Equities are generally higher-risk investments than other asset classes because their value can change quickly due to market ups and downs. However, over time, equities can also potentially provide better investment returns.
Within equities, there are also asset classes like:
- Canadian equity which invests mostly in Canadian stocks
- Foreign equity which invests mostly in non-Canadian stocks
- Special equity which invests in specific industries or sectors like real estate, precious metals or natural resources
Fixed income investments include investing in bonds and mortgages. Companies and governments issue bonds to raise money. Mortgage funds invest in mortgages. In both cases, you earn a return on your investment through the interest paid to you.
Bonds are generally lower-risk investments than equities, unless they’re high-yield bonds issued by a smaller company or an emerging market government.
Cash investments are short-term investments that provide a specific interest rate. These investments often mature in a year and aren’t used for long-term investing.
Cash investments are generally the lowest-risk asset classes and can be turned into cash quickly. However, because their potential rate of return is lower than equities, they may struggle to keep up with the rate of inflation.
This includes asset allocation funds which consist of a diversified mix of investments and fund managers.
It also includes balanced funds which are a diversified investment mix which can include equities, bonds, mortgages and cash investments.
The importance of diversification
All investments have risk, just some more than others. Manage your exposure by diversifying your investments across different levels of risk within your plan.