Primary Asset Classes

"The most valuable commodity I know of is information. Wouldn't you agree?"
--Gordon Gekko (Wall Street)

Investors generally choose from four primary asset classes:

1) Cash. Cash is the fundamental asset class upon which other asset classes are based. It is denominated in units of currency (e.g., dollars). Cash is liquid, meaning that it is easily exchanged at its nominal value (e.g, 'one dollar'). It carries low short-term risk, meaning that its value is unlikely to decrease over the next few days or weeks. Over longer periods of time, however, the value of cash can decline in inflationary environments when the creation of additional money (typically by government) causes the purchasing power of cash to go down.

That said, the primary objective of cash is capital preservation. In uncertain times, or as a parking place for investment capital until better opportunities arise, cash can be an attractive asset class.

2) Fixed income. Fixed income includes a variety of investment vehicles ranging from bonds (both government and corporates) to certificates of deposit (CDs). Fixed income securities usually pay predetermined streams of income to their owners over the life of the investment. The timing of these payments is nearly always pre-set as well (e.g., monthly, semi-annually, annually, at maturity). This predictability is an attractive feature of fixed income instruments. A primary risk for owners of fixed income is 'credit risk,' meaning that it is possible that the borrower who sold the debt may default on some or all payments. To compensate, investors demand higher interest rates from debtors deemed to be riskier.

The primary objective of fixed income is predictable income or cash flow.

3). Equities. Equities, also known as stocks, are investments in for-profit companies. Partial ownership of a company is obtained by purchasing its shares either directly or via funds (mutual funds or exchange traded funds (ETFs)) that hold its shares. Equity shares can commonly be purchased on a stock exchange such as the New York Stock Exchange (NYSE) or the National Association of Securities Dealers Automated Quotations (commonly called the 'NASDAQ').

Stocks entitle the owner to participate in future wealth-building activities of the company that can result in share price appreciation (a.k.a. 'capital gains') or dividend payouts. Of course, owners also face risk that the company may not perform well in the future, thereby causing share prices to drop or dividend payouts to decline/terminate. The risks associated with stock ownership generally exceed those associated with either cash or fixed income. However, the rewards are generally greater as well. (Remember that risk and reward are related: the higher the risk, the higher the prospective reward, and vice versa. If that was not the general rule, then markets would have trouble functioning)

The primary objectives of equity ownership are capital appreciation and dividend income.

4) Alternative assets. The three asset classes discussed above--cash, fixed income, and equities-- are considered 'conventional' asset classes and comprise the bulk of investment portfolios. However, over the past few decades, financial market innovations have enabled investors to gain exposure to another group of assets called alternative assets. Alternative assets, sometimes termed 'hard assets' because they typically involve tangible goods, include commodities (such as oil, farm products, and gold), real estate, and even collectibles such as art. In the old days investors wishing to own alternative assets had to buy the tangible property and hold it in physical form. Today, many alternative assets have been 'securitized,' meaning that investors can readily buy exposure to them through ETFs and related vehicles. Many of these securities carry idiosyncratic risks, however, and investors must understand these risks before getting involved with this group.

Alternative assets can be attractive from two standpoints. Owning hard assets such as real estate or gold can be an effective way to hedge against inflation and other forms of financial or social disorder. If the value of the dollar goes down, for example, then the price of land or gold typically goes up. Another feature of alternative assets is that their value often moves up and down in a manner that is weakly or even negatively correlated to stocks and bonds--making this asset class an attractive way to diversify an investment portfolio.

The primary objectives of alternative assets, then, are inflation/disorder protection and diversification.


One of the major decisions facing investors involves 'asset allocation,' or how to divide their capital among the four above asset classes. We'll discuss in a future post.

position in gold