Asset Allocation Basis Part 1: Know Your Asset Classes

I’ve been reading your comments from my giveaway post where I was asking what you wanted to read about on Green Panda Treehouse. Many of you expressed the interest to read more about asset allocation and how to invest savings at a young age.

So I decided to start an “asset allocation series” that will describe which kind of asset classes you may choose to invest in and how to manage your asset allocation depending on your age, financial situation, investment goals and, most importantly, how you sleep at night with your asset allocation (i.e. tolerance for risk). This will probably be a lengthy series since there is so much to read about. This is why you will have an “asset allocation post” about once a week and they will be regrouped in a special section of this blog.

You want to learn how to manage your asset allocation properly? You first need to know which kind of asset classes you can invest in! Today, I’ll first review the major asset class categories and in a second post, I’ll subdivide each of them, but let’s just start with a definition of asset class and asset allocation:

Asset class definition:

“Asset allocation is the strategy used in choosing between the various kinds of possible investments, in other words, the strategy used in choosing in what asset classes such as stocks and bonds one wants to invest.

A large part of financial planning consists of finding an asset allocation that is appropriate for a given person in terms of their appetite for and ability to shoulder risk. This can depend on various factors; see investor profile.” (wikipedia)

Asset allocation definition:

Asset allocation is the strategy used in choosing between the various kinds of possible investments, in other words, the strategy used in choosing in what asset classes such as stocks and bonds one wants to invest.” (wikipedia)

Asset class #1: Liquidity

This is probably the most simple asset class you can invest in: CASH! Your liquidity can be found as pure cash in your investment account, in a high yield savings account (such as SmartyPig), in T-bills (treasury bills with maturities less than one year out guaranteed by the government of a country) or in a money market funds (a fund where the manager trades different t-bills and short-term notes in order to generate a higher yield).

This asset class is used for transactional purposes. If you want to invest money in another asset class, you will need use your liquidity. Therefore, the objective of this money is to get the highest yield possible considering 2 major factors upfront: #1 capital security, #2 capital liquidity.

Asset class #2: Fixed Income

The fixed income part of your investment portfolio will be the part where you will keep your “safer” investments that generate regular income. It doesn’t mean that this money will be 100% guaranteed, but this is the next safest asset classes. By safest, we often mean the one with least volatility (fluctuations in current value). As they will rarely show a supercharged yield, they will rarely drop by 20% as well. Since you have several types of fixed income, I’ll let you discover them in another post of this series.

Asset class #3: Stocks

If I have to make an analogy, I would compare the fixed income as the body of your car that will protect you and put everything together and I would compare stocks as the engine and fuel of the car.

Stocks are issued by companies so investors can “own” a very small part of the company. For example, if you buy 100 shares of Apple (this will be quite costly ;-) ), you will own something like 0.000001% of the company ;-). If the company goes well and shows strong financial results, your stock will increase in value since the company will be worth more overall. There are several ways to invest in the stock market, some riskier than others. We will take a look at them later on.

Asset class #4: Others

Believe it or not, there are tons of other asset classes! While most investment products are covered between fixed income and stocks, you can also go into more complex products such as linked notes, derivative products such as options or commodities (oil, gold, copper, crop, etc.). I’d say that using those other asset classes require more investment knowledge. However, I will still show you how you can participate in those asset classes without running into a brick wall!

If you have any specific questions regarding asset allocation, please comment below. I’ll include the answers to your questions in my upcoming articles.

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8 Responses to Asset Allocation Basis Part 1: Know Your Asset Classes

  1. This is great. Start from the basics and build on top of that. Love the new website layout.