Other Asset Classes
Now that we have a solid understanding of the three main asset classes, we can start learning about the other asset classes that are really important, but fall outside of the Big Three asset classes we saw before, stocks, bonds, and cash.
The Three Other Asset Classes
Let’s rewind a bit and remember that an asset class is formed by a group of investments that have similar characteristics and behave in a similar way. There are many ways of investing in real estate. However, some real estate investments could be classified as fixed income (bonds), since they have some similar features, like the fact that their periodic payouts in the form of rent have a certain resemblance to interest gains from bonds. Also, other types of real estate investment have features that resemble that of equity investments (stocks), given that, instead of owning a share of a company, you’d own a share of a building or a complex.
There are a few reasons why real estate is classified as a separate asset class. One of them is certainly its lower liquidity. It normally takes a fairly long time to sell a house or a building, and selling most stocks or bonds is don virtually automatically. Another important reason is that real estate laws and regulations are different from those in stocks or bonds since you are dealing with ownership of strictly physical assets (houses or developments). Generally, real estate behaves differently than other assets, its cash flow structure is different and its market cycles are somewhat independent.
Owning real estate is generally a good investment if the proper research and care are put into it. It typically offers the owner steady cash flows and it is a good way to diversify your portfolio, more on that later.
Note: in 2008, real estate speculation was one of the main causes of a global economic crisis that is still affecting certain parts of the world, so please, do NOT think real estate is always a good investment.
The dictionary defines it as “a raw material or primary agricultural product that can be bought and sold, such as copper or coffee.” Most end products we buy today are made of a wide variety of raw materials. For instance, our warm, morning coffee is made of coffee beans or our phones, which are made of a variety of metals, plastic, and glass. All the above materials are or come from raw materials that are bought and sold as commodities on a daily basis.
There are three main types of commodities:
- Agricultural: or soft commodities are commodities like sugar, soybeans or cattle.
- Plants we consume: coffee, tea, wheat, etc.
- Animals we eat: cattle, sheep, etc.
- Things you don’t eat or drink but use on a daily basis: cotton, wood, etc.
- Metals & Minerals: or hard commodities are precious materials like gold, silver or diamonds.
- Energy: such as crude oil, gas, natural gas, etc. They are used to power our houses, cars, etc. Other energy investments are becoming very popular, the renewables, such as solar energy or wind energy.
This third asset class is really broad (maybe too broad), so we will have different sections for the most important alternative investments in future sections. Alternative investments range from pieces of art to collectibles, to cryptocurrencies. They are grouped into the same broad asset class because they are typically of riskier nature and they offer higher return expectations.
- Private equity investing is one of the most important alternative investments. It is essentially the partial ownership of a company that isn’t traded in the stock market. Private equity investing can be very profitable but it is risky since information on private companies is limited and they are normally newer, less well-established endeavors. Also, they are less liquid than public companies, since the number of buyers is normally more scarce and contracts with private firms may lock the capital for a pre-established period.
- Art is another form of alternative investing. It is estimated that the outstanding value of artwork in the world is about $3 trillion. The fine arts market is evolving as cultures around the world change. The population is getting richer, especially in emerging countries like China, which is one of the biggest art importers in the world.
- Cryptocurrencies, like Bitcoin or Ripple, are a newer, interesting alternative asset. These are digital assets that are used as a way to exchange capital in an encrypted and sometimes anonymous way, it is basically digital cash. Crypto prices are extremely volatile and risky, and by the definition of investing, allocating money to cryptocurrencies is speculating, bubbles are easily created and destroyed with very little possible explanation or analysis. The technology behind cryptos, however, is called blockchain, and it is an innovative, growing technology.
All these alternative assets are good options to keep in mind in order to maximize your portfolio diversification, as they have different characteristics and behave differently in different economic situations. We will revisit them in future sections when we lay out how to optimize your portfolio.
In the next section, we will finally discuss what diversification is and we’ll start talking about how to achieve it.