A group of securities that exhibit similar financial characteristics and behave the same in the marketplace is known as an asset class. Asset class examples include equities, which offer an ownership stake in a business. The familiar term for equities is stocks. Fixed-income securities, known as bonds, pay a fixed return at regular intervals over a period of time, after which the investor’s principal is returned. Money market investments, which include government securities and certificates of deposit (CDs), pay a fixed interest rate and can be liquidated easily. Lastly, there is real estate. Assets classified as real estate include a person’s residence, rental or investment properties, as well as commercial real estate holdings.
Equity investing involves buying stock in a private company or group of companies. Doing so confers an ownership share in those companies to the investor. When the company increases in value, stockholders’ investments in the company increase in value as well. However, when the company loses value, so do the portfolios of investors heavily invested in the company. Other than dividends – fixed regular cash payments enjoyed by preferred stockholders – equities offer no guaranteed payments or rates of return. An investor can gain 100% or more on an equity investment in a year; he can also lose his entire principal. It is entirely dependent on the performance of the company.
People investing in equities must weigh the risk against the potential return. In finance, risk and return correlate positively. The more money an investor can make on a particular investment, the more he stands to lose from it as well. Equities offer the potential to make a lot of money, as investors aren’t shackled to a fixed rate of return, such as 6% or 10%. An investor who purchases Company XYZ shares at $100 and sells them a year later for $150 makes a 50% return. Just as investors aren’t limited by a fixed return, they aren’t protected by it, either; if Company XYZ shares drop to $50 each, the investor loses half his money.
Real estate, long considered safer than equities, showed its ugly side in the late 2000s, when property values in many U.S. regions plummeted by more than 50%. Like equities, real estate provides no guarantees. Moreover, investors must consider additional costs endemic to real estate, including maintenance costs and property taxes. The roof cannot leak on stock or bond investments, but it can leak on an investment condo in Florida.
Equities and real estate subject investors to more risks than do bonds and money markets. They also provide the chance for better returns, requiring investors to perform a cost-benefit analysis to determine where their money is best held.