Financial service companies structure their business activities around asset classes. Seasoned investors do the same with their portfolio. Why and how?
If you build an estate to have funds available for your retirement, for an investment or for the education of your children you have to decide where to put your money.

You could buy

1. Stocks
2. Bonds
3. Real estate
4. Natural resources
5. Gold

Your savings will end up in these asset classes, even if you delegate their management e.g. by buying an insurance policy, which will promise you a monthly payment after you retire. They also have to invest the funds you sent them to get a return on top of the principal.

The use of asset classes can helps you to manage them properly and to balance the risks you take. This is done by grouping together financial assets with similar characteristics. The sorting criteria have to with the nature of the assets as well as with their behavior in certain risk scenarios. I want to give you here a short run down of the most commonly used categories for financial assets:

Equity
You find in here investments giving you ownership rights of a business. Examples are shares traded at a stock exchange or stakes in a partnership etc. Ownership means the right to influence business decisions e.g. through voting rights, and the right to receive a share of the business profits. There is no guarantee on any future payment. If the business does not earn a profit, the shareholder will be left empty handed. And if a business goes bankrupt, equity in this business has lost any value whatsoever.

Debt
Debt means in this context that you lend somebody some money against the promise of a sequence of return payments to give you back the principal and the agreed interest. In this case you have a legal right to receive these return payments. The debtor cannot say “I did not make a profit this year, so I cannot pay you anything.” If a business or a private person cannot meet the payment obligations coming from a lending contract, the result will be bankruptcy. In this case a court will supervise how the remaining assets of the business will be divided up between the people to whom the debtor has payment obligations. The debt holder does not have a right to influence business decisions as long as the debtor fulfills his contractual obligations

Real Estate
The real estate asset class comprises ownership rights on land and buildings on that land. If you hold real estate assets not for your own use, but to generate a cash flow, you may look at it as a special form of equity. But the difference between a real estate investment and a typical equity investment is the fact that you do not have clear information about the value of a piece of land or a building every day. It may take several months to sell it, and you will know the price only at the end of the sales process. In contrast to that, you can sell shares of a big company with a few mouse clicks; you will have price quotes at least on a daily basis

Commodities
If you invest in commodities, you buy a quantity of clearly defined items, mostly natural resources. Most commonly traded are metals like copper, silver, aluminum, agricultural commodities like corn, lumber and wheat, or minerals for energy supplies like crude oil or coal. Commodities are items you own, whereas equities are rights you own. They have a well defined market price at any time, and a use value. Another important characteristic of commodities is that you need to store them if you own them. To store them implies costs.

Gold
Gold is in a commodity, which at times takes on the role of money. The reason for the monetary role of gold is the limited supply and the fact, that gold is easy to store. It will not be damaged by water, light, heat, frost. It won’t break if fallen down. You can hide it in the soil of your garden, and if you dig it out after 100 years it will still be the same amount of the same gold.

These are in five generic asset classes. All of them have their strengths and their risks. While real estate may provide a safe and enjoyable place to stay in normal times, and debt a steady cash flow, the asset classes of gold and equities may provide better protection from inflation. Commodities may protect against political risks and may rise in times of crisis and war, but there is a cost involved in holding them. The cost of holding commodities can be greatly reduced by the use of futures and options instead of holding the underlying assets themselves.

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