Understanding Asset Classes in Investing - NerdWallet (2024)

Canadian investors looking to get into the market for either the short or long term have almost endless options. Not all products are well-suited to all investors, so it’s important to understand how the main types of investments are grouped together and what exactly happens to your money once you invest.

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What is an asset class?

Asset classes are groups of similar investment products. These vehicles behave similarly on the market and are subject to similar rules and regulations. Investing in several types of asset classes helps diversify your portfolio and minimize risk, which is an investing strategy referred to as asset allocation.

Generally, investments fall into five broad asset classes:

1. Cash and cash equivalents
2. Fixed-income securities
3. Stocks and equities
4. Investment funds
5. Alternative investments

Within those buckets are many offerings that can be held as part of a diversified portfolio or by themselves, depending on an investor’s risk profile.

Here’s a closer look at the five major asset classes and some of the most popular types of investments within them that Canadian investors should consider.

Cash and cash equivalents

Cash and cash equivalents give you easy access to your money and don’t typically require a lot of upfront costs. They are widely considered low or no risk since the capital put in is guaranteed but offers lower return rates than other asset classes. Some cash equivalents are also considered fixed-income investments.

Examples of cash and savings-like investments include

• Money in your bank account
• High-interest savings accounts
• Federal and provincial treasury bills
• Guaranteed investment certificates (GICs)
• Money market funds

Treasury bills

Treasury bills, or T-bills, are 100% guaranteed debt securities issued by provincial and federal governments that need to raise capital.

How do investors make money? T-bills increase in value over time, so investors make money by selling the t-bill for more than its original purchase price, known as the effective yield rate.

Guaranteed investment certificates (GICs)

A GIC is like a loan, but you’re lending money to your financial institution for a set amount of time, or term (usually between one and five years for a long-term GIC, or as little as 30 days for a short-term option). The institution agrees to pay back your money at the end of the term, plus a fixed or variable interest rate.

How do investors make money? GICs may pay interest regularly or at maturity. Others may be cashable or non-redeemable during their term, and some are market-linked, giving you the potential to earn more interest if the market rises. In general, the longer the term of your GIC, the higher the interest rate you’ll be offered.

Money market funds

Money market funds are short-term (up to 12 months) investments that provide a fixed rate of return when you hold them to maturity and provide liquidity, which means you can access your money if needed during the term of the investment.

How do investors make money? Investors make money on cash equivalents by earning interest on the capital invested — typically once the product reaches maturity.

Fixed-income securities

Fixed-income securities, such as bonds, are a type of fixed-income investment that essentially loans to a company or government. When you purchase the bond, you agree to lend them money for a certain amount of time, known as a term. In exchange, they’ll guarantee to give you the principal amount back, along with regular interest payments. Terms to maturity can range anywhere from one day to 30 years.

How do investors make money? You’re getting a fixed amount of interest with bonds, either paid regularly or when your bond matures. If your bond goes up in price during its term, you could also make money by selling it before its maturity date.

Stocks and equities

When you buy a stock or equity, you own a share of that company and can participate in its gains, losses and any dividend payments. This asset class can offer high returns but comes with a higher risk of losing your investment.

Stocks are divided into two categories:

• Common stock allows investors to vote at shareholders’ meetings and benefit from increasing dividend payments. Restricted voting shares are a type of common stock that does not come with voting rights.
• Preferred stock offers shareholders fixed dividend payments and priority for company assets over common shareholders if the company goes bankrupt.

Beyond those basics, the options for investing in equities are endless. Stocks typically trade on exchanges and are broken down into categories depending on factors like their size and market capitalization, geographic location, sector or investment style.

How do investors make money? Investors make money on stocks in a couple of ways. The most obvious is when the stock increases in value and you sell it for more than you paid for it. Some companies may also pay shareholders regular dividends. Read our guide to learn how to start investing in stocks.

Investment funds

An investment fund is an alternative option for investors who aren’t interested in choosing or trading specific stocks. Investment funds are a basket of investments — a collection of stocks, bonds or both that typically focus on one or more asset classes. For example, the fund may invest primarily in Canadian equities, global bonds, stocks from a certain sector or only small-cap companies, to name a few.

Your money is pooled with other investors’ money in an investment fund, and the portfolio is managed by a professional fund manager who selects investments on your behalf. Funds often charge management fees or other fees and require a minimum investment.

Investment funds include mutual funds, index funds, and exchange-traded funds (ETFs).

Mutual funds

Mutual funds are a common type of investment fund that gives you the right to vote on major decisions on how the fund is managed. The value of your shares in a mutual fund goes up or down depending on the underlying value of the holdings in the fund. You may also get dividends or other income payments, depending on the type of fund you hold. Since mutual funds are actively managed by a fund manager, they tend to have higher fees.

Index funds

An index fund aims to track the performance of a particular index, such as the S&P 500 or Toronto Stock Exchange (TSX), by holding either all of the securities in that index or a basket of stocks that are representative of its holdings. As they simply track the underlying index, these funds are considered to be passively, rather than actively, managed. They can also only be bought or sold at the end of the trading day.

How do investors make money? Mutual and index funds may pay distributions of dividends, interest, capital gains or other types of earned income. The level of risk, and profit potential, varies based on the investments a fund holds. However, since these funds are managed by a professional, they are typically a smart choice for new investors.

Exchange-traded funds (ETFs)

Exchange-traded funds (ETFs) also hold a collection of securities or bonds and are listed and traded on an exchange, such as the TSX. ETFs can be passively managed, in which case they will closely follow an index, or less commonly, actively managed, where a manager will seek to outperform a benchmark. Investors may have to pay a trading fee to buy and sell an ETF.

How do investors make money? ETFs can be bought and sold on the exchange at any time during the trading day (under a ticker symbol), just like stocks. An ETF’s share price is subject to the value of its holdings and demand.

Alternative investments

In the more sophisticated category are alternative investments that are all structured differently in terms of how they work, how they generate returns and how much you’ll need to invest.

Their common link is that they often have different risk profiles than traditional investments and usually require investors to have a certain amount of investment experience, advice or financial knowledge before diving in. In addition, some alternative investments offer a low correlation to the market movement of stocks and bonds, so they can help diversify a portfolio and offset risk.

Examples of alternative investments include:

• Real estate
• Foreign currency
• Cryptocurrency
• Hedge funds
• Private equity
• Commodities like gold, silver, energy and agriculture
• Options
• Futures and forward contracts
• Income trusts, like real estate investment trusts (REITs)
• Collectibles and physical assets like fine art, stamps, rare wines, and more

Real estate investment trusts (REITs)

Trading as units on an exchange, REITs invest in different types of real estate assets (industrial, commercial or residential) and produce income in dividends. Most REITs are considered income trusts. You can also invest in a basket of REITs in the form of a REIT ETF.

How do investors make money? REITs pay out their taxable income in the form of dividends to shareholders, typically on a monthly basis.

How to purchase investments from different asset classes

Once you’re ready to start investing, how you purchase your investment will depend on the type of investment product you choose. While most asset classes, including stocks and fixed-income investments, can be bought through an account with an online trading platform or broker, you can also purchase some, such as mutual funds, at your financial institution or via your financial advisor. If that investment dealer is a Canadian Investor Protection Fund (CIPF) member, you’ll benefit from CIPF coverage which protects the money in your investment accounts.

You can hold most types of investments in a registered account, such as a tax-free savings account (TFSA) or registered-retirement savings plan (RRSP), which can accelerate growth and help you avoid taxes.