An asset class is a group of investments that share the same features and undergo the same compliance and regulations.
Understanding what asset classes are and how they work is the basis of any investment strategy. This comes in handy when allocating your asset classes in a way that your investment will work for you. I will guide you in understanding the different types of asset classes. In fact, I will make sure by the end of this guide you understand how to spot investment opportunities in asset classes and how to take advantage of those opportunities.
What are the Major Types of Asset Classes?
An asset class that represents ownership of a company. When you buy equity/stocks of a given company, you are committing to own a fraction of that company. According to a study by Pew Research, at least half (52%) of the American population own stocks.
2.Cash and Cash Equivalents
You have heard the term liquidity before. The extent by which an asset can be quickly sold at a price that reflects its innate value. Cash and Cash equivalents are an asset class with high liquidity and high credit quality. Simply, they are the total amount of cash at hand, anything similar to cash or current assets that can quickly be transferred to cash.
3.Fixed Income (Bonds)
An asset class that reflects the value of money that an individual/entity has lent to a company, organization, or government. Basically, this is lending money to organizations for an interest.
What are Equities and How to Invest in Them?
Equities are units of ownership of a company, also referred to as stocks. Buying and selling of stocks take place on a stock exchange. The stock exchange lists different companies and allows shareholders to come together and trade their equity.
Ownership of equity in a given company entitles one to certain benefits, depending on the type of equity/stocks. You might be wondering, why should you invest in stocks?
Well, take these statistics carried out by Financial Samurai, for the past 60 years stocks have posted 8-10 percent returns. Comparing these figures to real estate returns posts a difference of at least 4 percent.
A stock is the smallest fraction of ownership of a company. They are one and the same thing as equity/shares. Buying a stock attracts returns in the form of dividends. Usually, companies raise capital by selling shares of stock. A company trading its equity means it is ready to have several investors purchasing and owning a part of the company. Nonetheless, they are several ways for companies to raise capital, namely through the issuance of bonds. However, unlike buying bonds where you won’t have any ownership stakes in a company but remain as a creditor; equity grants you certain privileges such as:
- Dividends – A share of the company’s profits that are distributed regularly to shareholders. Buying equity makes you a shareholder and therefore a rightful recipient of a company’s share of profits.
- Capital Appreciation – A company’s equity/stocks will go up or down depending on prevailing economic conditions. In effect, the price of equity/shares will either go up or down respectively. When the price of stocks increases, the value of the equity/shares also increases.
- Voting Rights – Owning equity in a company may grant you the right to vote during the company’s yearly shareholder general meeting.
You can only purchase stocks of a public limited company listed on the stock exchange.
However, a private Company makes shares/equity available to the general public through an Initial Public Offering. You have seen the phrase “Going Public” and perhaps wondered what that was. Simply, when a company goes public, this means the company is conducting an IPO for the public to buy shares/equity.
The private company discloses the number of shares it will issue and sets a price for the IPO. Funds raised during the occasion are transferred directly to the company. Finally, after the IPO – respective shareholders can trade their stocks on the secondary market, otherwise dubbed the stock exchange market.
Different factors determine the fluctuations of stock prices and hence the returns one could earn.
Example of Shareholder’s Equity
Factoring the following definition of equity, consider the example that will follow.
Equity represents the value of money that a shareholder (s) will receive after liquidating all of a company’s assets and clearing all debts.
Shareholders Equity = Total Assets – Total Liabilities
To determine the shareholder’s equity during a given financial year, identify the total assets and total liabilities on that year’s balance sheet and subtract. Remember that basic accounting holds for a balance sheet the equation:
Total Assets = Total Liabilities + Shareholder’s Equity