5 Main Types of Assets
Investments can be divided into 5 major asset classes. Each asset type should generate income and/or cash flow but which asset class will give you financial freedom?
The 5 major types of asset classes include:
- Paper Assets
- Real Estate
We often get asked: what’s the best investment? Our answer is usually: it’s a personal choice that depends on your goals and specific interests. Each type of investment has advantages AND disadvantages.
In terms of your goals... are you looking to become financially free or are you just looking for an extra passive income source to complement your earned income through a job? What risk tolerance do you have and what time frame are you looking for? What is your financial IQ?
In terms of personal interests...some people may find the price of oil to be completely boring, whilst others will find it fascinating. Furthermore, some investors may like the challenge of owning a multi-family apartment complex while others will prefer to invest in a real estate investment trust (REIT).
Portfolio Diversification Across Multiple Asset Classes is The Key
Although it is important to choose an asset class that you are interested in, ultimately, it is more important to have a diversified portfolio. What does diversification mean? Traditionally, financial planners often refer to the importance of having a ‘diversified portfolio’. However, they usually refer to a diversified stock portfolio (i.e. owning stock and equities in multiple sectors, company market cap sizes, blue chip and global markets).
But true diversification to us means investing across multiple asset classes. You need to look beyond just a single asset class as different investment types will react to different market conditions and pressures at different times. Having investments in many asset classes will help you generate different sources of cashflow (taxed differently as well) in addition to giving you the ‘buffer’ during different market conditions.
In order to be able to invest in many asset classes, you need to increase your Financial IQ. Below are the 5 major types of assets that you can consider:
Asset Class #1: Paper Assets
What are paper assets? Paper assets are probably the most popular asset class as they are highly accessible, most liquid (can get in and out very quickly), easier to understand and require ‘low’ financial IQ. There are numerous paper assets to choose from and they can deliver capital gains and/or cash flow. Most people will invest in paper assets through a financial planner or by themselves through a brokerage.
Paper assets include:
- stocks (dividend or non-dividend paying equities)
- stock options
- stock futures
- ETFs (exchange-traded funds)
- mutual funds
- retirement accounts (401k or RRSPs etc)
- foreign exchange (currencies)
- real estate investment trusts (REITs)
One of the challenges is that most people own only paper assets (retirement funds or investing in stocks of companies that they like) in addition to their own home (primary residence) but this does not mean that their financial portfolio is ‘diversified’. In fact, the majority of people only invest in 1 of 5 major asset classes: paper assets. This does not give you a diversified portfolio even if you invested across many sectors, global markets and/or sizes of companies.
Asset Class #2: Commodities
What are commodities? As an asset class, commodities represent investments in ‘useful’ things in this world that have value (or perceived to have value). Investing in commodities require a higher Financial IQ then investing in paper assets.
- metals (gold, silver, copper, rare earth)
- energy (oil, gas)
- food (sugar, rice, coffee, corn, meat)
- raw materials (cotton, lumber)
- buy the actual physical and tangible asset (like a gold coin)
- purchase futures contracts on an exchange/brokerage
- buy the digital asset pegged or linked to the price of the actual commodity
A challenge with commodities is that they are generally a capital gains or loss investment that doesn’t generate passive income. They are also harder to leverage in regards to getting equity out while keeping your commodity investment.
Having said that, virtual currencies (or crypto) allow investors to invest in ‘commodities’ through ‘synthetic tokens or assets‘ as well as other digital assets that are pegged to the price of commodities. These synthetic assets can also generate passive income.
Asset Class #3: Business
What are business investments? Investing in established companies or start-ups is another asset class. However, it requires a lot of due diligence and higher financial IQ. Not only do you have to research and analyze the business in detail, but also the partners, management team, ethics, financing, timing and possible returns. Most people are not financially educated to make these big decisions.
Business investments include:
- invest time and/or money in your own company
- invest time and/or money in someone else’s private company
- invest in a startup through crowdfunding
Much like the ever popular reality TV shows like Shark Tank and The Apprentice, an investor will invest in a business to generate capital appreciation and/or passive income, the best of two worlds. Obviously this type of asset class is much more complicated, requires a lot more research and due diligence as well as patience.
Asset Class #4: Cryptocurrency
What is crypto? Crypto or cryptocurrencies are also known as ‘virutal currencies‘. They are the newest asset class that fits between paper assets and commodities whilst offering the best features of both. They are highly accessible and is often called the ‘people’s money‘ as they are decentralized on blockchains and not completely regulated by the government.
- coins & tokens (Bitcoin, Ethereum, Litecoin)
- privacy-focused assets (Monero, Dash, Zcash)
- stablecoins (USDT, USDC, PAX, DAI, TUSD, UST)
- digital gold (XAUT, PAXG)
- synthetics (like lumber or pork)
- leveraged tokens (like stocks and equities)
Crypto currencies also provide a means of exchange or for investors to store wealth. Each asset is highly divisible and transferable with low to no fees. Cryptocurrencies are traded much like paper assets (on exchanges), but with the evolution of Centralized Finance (CeFi) and Decentralzied Finance (DeFi), investors in crypto can now focus on not only generating capital appreciation, but also passive cashflow with high returns. This is probably one of the biggest advantages of cryptocurrency over paper assets. However, crypto assets are highly volatile in price swings and are considered a ‘riskier‘ form of investments due to its unregulated nature.
Asset Class #5: Real Estate
What is real estate investing? Last but not least is real estate. Property investing is one of the most amazing asset classes as the advantages far outweigh its disadvantages. It is the asset class that you get you out of the ‘rat race’ faster and gain financial freedom earlier. However, it is also the most time and labor intensive asset class, unless of course you outsource everything (which will minimize your returns).
Real Estate investments include:
- residential property (single family or multi-family)
- commercial property (business/office space, storage, parking lots)
- recreational property
As we touched on in our ‘3 Types of Income‘ article, real estate investing provides investors with 2 types of income: portfolio income (through capital gains from buying and selling property) in addition to passive income (positive cash flow through rental income minus expenses).
Real estate investing also allows for the use of leverage (good debt) as well as the ability to use other people’s money (OPM) to purchase and finance the asset. This particular asset class provides the best leverage options whilst giving you a great combination of future capital gains and consistent cash flow through passive income. However it certainly requires due diligence, research, patience and a high financial IQ.
Asset Classes In a Nutshell
In summary, there are 5 main types of assets: paper assets, commodities, business investments, cryptocurrencies and real estate.
Each asset class has its advantages and disadvantages. All provide a chance for capital appreciation (capital gains or portfolio income) but not all asset classes generate consistent positive cashflow (passive income). The latter is required to become financially independent.
In regards to time, experience and financial education, some asset classes such as paper assets are easily accessible and require low financial IQ while other asset classes such as real estate are less liquid and require higher financial IQ.
Therefore, it is up to you to determine your risk tolerance, initial capital available, type of income you want to generate, your goals and interests. This will give you more insight into the type of asset that you want to invest in both short and long-term. We hope you enjoyed our write-up on the different asset classes available to everyone.