Before you start investing your money, it's important to have a working knowledge of the different types of investments and how they relate to one another.
Simply stated, asset classes are different categories of investments grouped together. Although there are several different asset classes, we’re going to focus on the three most common types.
What are the most common asset classes?
There are three main types of asset classes: stocks, fixed-income investments, and cash equivalents.
Stocks (also called equities)
Stocks have historically earned the highest returns over the long term. Stocks represent a partial ownership interest in a company. The value of a stock can be influenced by many factors, such as the performance of the company, the economy, or regulations. A stock’s value can generate returns for stockholders through price appreciation – this is when you sell the stock for more than the purchase price, and dividends – this is when you receive periodic distributions of the company’s earnings. Stocks have shown more short-term ups and downs in price – this is known as volatility. Because of this, in most cases, an investor should plan to hold stocks for the long term in order to ride out these ups and downs.
The higher the price volatility, the longer the investment time horizon.
In a 403(b) plan, it’s common to offer stock mutual funds. This is where a professional money manager selects and manages the individual stocks within a fund. You, as an investor, can then choose to invest in the stock mutual fund – which is essentially a basket of individual stocks.
Fixed-income investments (also called bonds)
Fixed income or bonds have historically earned lower returns than stocks over the long term because they generally experience less ups and downs than (or you can say – because they generally have lower volatility than) stocks over the long term. A bond is typically an agreement to repay an investor’s principal and interest on a specified date in the future.
In a 403(b) plan, it’s common to offer fixed income mutual funds. Similar to stock mutual funds, a fixed income mutual fund is managed by a professional money manager that selects and manages the individual bonds within a fund. You, as an investor, can choose to invest in the fixed income mutual fund.
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. However, they may not protect your retirement nest egg from the effects of inflation (which causes a loss in purchasing power). If CPI is 3% a year, if you don’t earn at least 3% on your money, you are losing purchasing power.