Asset classes are types of appreciable investments that can be grouped and distinguished from one another based on the correlation of their price movements and the structure of their cash flows.
Some of the most common asset classes are stocks, bonds, cash (and cash equivalents), commodities, and real estate. Many individual securities and sub-classes will fall into each of these.
Asset classes are a large consideration when creating a well-diversified portfolio.
Constructing and maintaining an asset allocation that suits an individual investor’s risk tolerance, time horizon, and goals has been found to be the single most influential mode of control that an investor can use to keep the results of a portfolio reasonably predictable.
The idea is that if you would expect returns within a certain range out of an asset class, and several asset classes only have a moderate degree of correlation to one another, that the dips and turns of the individual asset classes will not affect the entire portfolio, and that they will, as a whole, generate returns within the desired range while avoiding some of the risks inherent in each asset class.
This is known as modern portfolio theory. Asset types that deviate from these more traditional asset classes are known as alternatives.
What is the Role of Asset Allocation in My Investments?
What is an Asset Mix?
How Do I Measure My Risk Tolerance?