As an educator, you're used to dealing with different classes every day. As an investor, you also need to deal with classes – asset classes.
Asset classes are simply different categories of investments. Here are some basic definitions of stocks, bonds and cash equivalents, considered the three main types of asset classes because they are the ones most commonly offered by employer-sponsored retirement plans, such as 403(b) and 457 plans:
Stocks (also called equities) have historically earned the highest returns over the long term.* Stocks represent a partial ownership interest in a company. You may want to include stock funds in your 403(b) plan account for their long-term growth potential. However, this asset class has also shown more short-term volatility (or ups and downs in price) than the others. Because of this, in most cases, you should plan to hold equities for the long term in order to ride out the ups and downs.
Typically, a major part of the total return earned by equities comes from appreciation, or an increase in price. (Some stocks and stock funds pay dividends, which provide a steady stream of income; but many do not.) If you hold a stock or stock fund and you want to capture an increase in price, you would have to sell it.
Fixed-income investments (bonds) have historically earned lower returns but experienced less volatility than equities over the long term.* Generally, a bond is a promise to repay an investor principal and interest on a specific date in the future. The lower volatility makes them more suitable for short-term, as well as long-term, holding periods. Also, much of the return normally comes in the form of interest payments. So, you can receive an ongoing stream of income without having to sell investments.
Cash equivalents, such as Treasury bills and money market funds, have experienced the lowest returns but also the lowest volatility of the three classes, over the long term. This asset class’s advantage is liquidity – the ability to convert the investment into cash quickly and easily.
* Past performance is no guarantee of future results. Source: "Ibbotson 2008 Stocks, Bonds, Bills, and Inflation Yearbook," Morningstar Inc.