According to Merriam-Webster, the definition of invest is “to commit (money) in order to earn a financial return.” Most people in the finance world will agree there are four major asset classes in which you can invest; and each of those four can be further broken down into smaller and smaller subcategories. The four asset classes are:
- Equities (aka stocks) where buying a stock gives you ownership in a share of a company
- Fixed income (aka debt or bonds) where you lend money and gain by the interest earned
- Cash and cash equivalents is just what it sounds like – your cash, whether in savings or in a shoe box under your bed
- Real estate and commodities where you buy and own something physical (like a physical property); this can take on the physical form in a tangible asset, or it can be in the form a fund
Equity Asset Classes
Because investing is WAYYYY too broad of a topic for one blog post, we’re breaking it down and just covering equity classes in this post. Equity assets are generally broken down by three methods: growth vs. value, location, and market-cap. Read on for explanations of what that even means!
Growth vs. Value Stocks
Regardless of company size or location, companies can be classified as growth or value. As the name implies, growth companies have a high potential for growth and are expected to grow faster than other companies. They put a premium on growth strategies and focus on reinvesting earnings into themselves rather than paying out dividends to investors. Because they’re often riskier in their growth strategies, they do have big upside potential but there are no guarantees of success. In terms of pricing, a growth stock price is usually high relative to sales and profit. People usually think of start ups when discussing growth stocks, but they can also take on the form of much larger companies, such as Amazon.
Value stocks have usually proven their business model and can be counted on to have steady, albeit smaller, growth over time. Because growth generally isn’t the focus, the company’s profits are often paid out in dividends to investors rather than in rising stock price. Because these businesses have been proven, they’re also usually considered lower risk. In terms of pricing, value stocks are typically lower relative to sales and profits.
Usually specific companies fall into either category, but often mutual funds will have a mix of the two and are called blends. Mutual fund managers will have a strategic mix of growth and/or value stocks to adjust risk and income levels of their fund.
Stocks by Location
This category shouldn’t need much explanation, but there are a few terms to be familiar with:
Domestic/U.S. – refers to companies based in the United States
Foreign Developed – refers to non-U.S. companies in countries with developed economies and generally accepted currencies
Foreign Emerging – refers to non-U.S. companies in developing nations/economies
World/Global – refers to investment funds which include the U.S. and foreign stocks. Because a company has a ‘home base’ individual stocks aren’t considered world or global, but often funds are classified as such to denote they have both domestic and foreign investments. These funds are often GDP weighted, resulting in a common mix of about 50% US and 50% Foreign
Stocks by Market Capitalization
Market capitalization, or market cap is a finance term for how big a company is. It’s the value of a company’s tradable stock, or shares outstanding times share price. The four main categories are:
Large-Cap – refers to a company valued at $10 billion or more; ex. Walmart
Mid-Cap – refers to a company valued at $2-$10 billion; ex. Whirlpool
Small-Cap – refers to a company valued at less than $2 billion; ex. Vonage
Micro-Cap – refers to a very small company, valued at less than $300 million; ex. Mesa Laboratories
Which Equity Asset Class Do I Need?
Answering which equity classes should be included in your portfolio is an integral part of our financial planning process, the Custom Wealth Architect™. Everything from risk tolerance, current investments, retirement goals, and legacy planning goes into determining the portfolio mix that’s right for you.
Whether or not you’re ready to invest in your future with financial planning, you should learn about your investment options and know what you’re putting your money into. The only bad investments tend to be the ones we don’t understand – for if we truly understand it, we’ll know if it’s a good fit.