your 401(k) #7: asset classes
How do you get the money in your retirement account to grow? You have to invest it! That means buying securities or assets that will increase in value and/or pay you income over time.
Retirement accounts like 401(k)s, 403(b)s, 457s, TSPs, and IRAs are NOT investments; they're just accounts that hold your investments. So what are your investment options? To keep things simple, they can be categorized into four main groups called asset classes.
An asset class is a group of securities (investments) that share similar characteristics and behaviors. Some asset classes do well, or go up, in certain market conditions while others do poorly, or go down. I recommend thinking about asset classes like different “buckets” in which you can invest your money.
THE 4 MAIN ASSET CLASSES ARE:
#1 - Cash
No, it’s not what you think. Cash assets can include stacks of bills in a savings account. However, when it comes to saving for retirement, there are other investments that make up the cash asset category.
The characteristics that these investments share are:
- Liquid - easily bought and sold
- Low risk - low chance of you losing your money
- Low return - small earnings made on your money
#2 - Equities
As covered in THE BASICS #3 - Equity, equity is ownership in a company. You can buy a slice of public companies by purchasing their shares on a stock exchange. Owning stocks or equities entitles you to that percentage of those companies’ assets and future profits.
Equities has been the best performing asset class historically. In other words, it has gone up the most over time. However, equities has also been the most volatile, or rocky, asset class. This is because stocks’ values fluctuate, or go up and down, often.
#3 - Fixed Income (aka Bonds)
This asset class basically includes all of the I.O.U.s of the stock market. In a bond, you lend a government or company money, called your principal. In return, they promise to pay you interest on your principal every year until they can pay you back.
The interest they promise to pay comes at a fixed rate, say 5% per year, and it’s considered income because it’s money you’re earning on your investment. Hence the name fixed income.
Historically, fixed income has been more stable than equities. But with that stability comes a lower return.
#4 - Alternatives
You may also hear this group called “non-traditional” assets. It includes a variety of investments that don’t fit into the other three traditional classes. Examples include: Real estate, Commodities, Hedge funds, Art and other collectibles
Some alternatives like gold and real estate are considered “hard assets” or “safe havens” and tend to perform better than stocks when people are worried about the economy. Because they’re non-traditional, alternative assets are sometimes less liquid, or harder to trade.
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If you remember to think about asset classes like different investment buckets, managing your retirement account will be much easier. Later on in this unit, we’ll talk about how to choose which buckets to invest your money in.