In order to better understand what an Asset Class is, let’s take the first word - “Asset”.
An Asset is anything (physical or non-physical) which might provide some sort of monetary value to its owner. For example, your education, skills and personality are all part of an asset called “Human Capital” - they are things which provide you (the owner) value - usually through making use of those skills in order to earn a living. Similarly, owning a piece of a company (a share) provides value to you as its owner, in the form of dividend income or when the company grows (capital growth).
We think of these assets in “classes” as a convenient way to group things together. We group them together because they share similar characteristics, and respond to specific risks in similar ways too.
So what do we mean by “similar characteristics”?
For example, stocks are an asset class because they all have similarities:
You own a piece of a company by owning a stock
You are usually entitled to have a say in how the company is run
You benefit if the company does well over time (get paid a dividend or the stock’s price increases).
As another example, let’s look at Bonds, which also have similarities:
All Bonds are effectively loans which you make to a company or government who wants to borrow money
Most bonds pay a “coupon” - this is like the interest rate a borrower pays you as the lender
You are entitled to your money back when the bond matures - at a specified time which is detailed when you initially lend the money
As a final example, stocks and bonds are quite different to another asset class like Commodities where you don’t own any company and haven’t lent any money, but instead own specific individual goods such as a barrel of Crude oil, an ounce of Gold or Silver, a kilogram of Cocoa, etc - all of which provide you some form of value if you own them, but are inherently different to stocks and bonds.
And what about “specific risks”?
We also group things like Stocks, Bonds, Commodities and other types of assets in separate buckets because from an investment perspective, they behave in similar ways when exposed to specific risks such as “interest rate risk” or “default risk”.
This grouping helps us intuitively differentiate between very different things - for example Stocks are an asset class which obviously respond to a very different set of risks versus something like Wine, which is also an asset class!
To better understand the point on asset classes responding to risks, let’s look at Real Estate (houses, office buildings, land, etc).
If interest rates go up (this is known as “interest rate risk”), real estate values usually move lower as a result (because the cost of borrowing money - the interest rate - is one of the key factors in determining real estate value). Other types of risks also apply to real estate - for example if companies re-locate away from one particular area, there would be less people living and working in that area, and it is likely real estate values would fall as a result (this is a form of “location risk”). While real estate values all respond to something like “location risk” in a similar way, it is unlikely that stocks, bonds or commodities would behave in the same way if this location risk materialises.
Please know, the value of investments can go up as well as down and you may receive back less than your original investment, meaning, when investing your capital is at risk.
Disclaimer: At Evarvest we believe in making investing and investment education more accessible, but we don’t provide investment advice and individual investors should make their own decisions. While we try our best, we cannot ensure the accuracy of the information we provide.
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