What are the asset classes?

The main asset classes

Investments are grouped into asset classes, families of securities that behave in similar ways.

Money market instruments

Short-term (under one year), low-risk debt that’s easy to sell:

• Treasury bills (T-bills): short-term US government debt, sold at a discount to face value.
• Certificates of deposit (CDs) and commercial paper (short-term company debt).
• Money market funds, which hold these instruments.

They pay modest returns, but their prices hardly move.

Bonds (fixed income)

Longer-term debt that pays interest (coupons) and returns the face value at maturity:

• Treasury notes and bonds: US government debt, 2 to 30 years.
• Municipal bonds: state and local government debt, often tax-free.
• Corporate bonds: company debt, which pays more because of default risk.
• Mortgage-backed securities: pools of home loans.

Equities (stocks)

Common stock is part-ownership of a company. Shareholders get a share of profits (dividends) and the company’s growth, but are paid last if the company fails. Preferred stock pays a fixed dividend before common shareholders get anything.

Stock and bond indexes

Indexes such as the S&P 500 and the Dow Jones Industrial Average track a market or segment. Index funds and ETFs let you buy the whole basket at once.

Derivatives

Options and futures get their value from another asset. They’re used to manage risk (hedging) or to speculate.

Risk and return

From money market to bonds to stocks, both the expected return and the risk generally rise. Derivatives can be riskier still, because of leverage.

Next: equivalent taxable yield.