An Overview of Assets: Part 1
What do people invest in?
The answer is assets. Assets in the context of investing are things that have value, and generally speaking, are things we expect the value of to increase over time. Some assets are more functional than others. Your house is probably the highest functioning asset you have, because you also live there. Some assets also produce a flow of cash (or “income”), like a rental property, or a dividend-paying stock.
Here are most common asset types, with bulleted sub-categories:
Equities (stocks). A stock represents a fraction of ownership in a corporation. Owners are entitled to a proportion of the corporation’s assets and profits. I’ll go deeper into stocks in a later post.
Domestic. These are companies that are incorporated in the U.S., likely most of the companies that you are familiar with. This doesn’t mean they don’t do business internationally. For example, Apple is headquartered in Cupertino, California. However, 58% of their Q4 2021 sales came outside of America.
International. While Domestic stocks have outperformed International stocks by 3% over the last 20 years (data below), that won’t be the case over every time frame. The main classifications within International are Developed and Emerging Markets. Developed countries have more stable economies, like the U.K. and Japan. Emerging Markets are countries that are growing fast, like India or Africa, but more volatile.
Bonds. A bond is something that a company or government entity issues to borrow money. To compensate you for the money lent, they pay an interest coupon, representing the annual interest rate paid as a % of the loan. The higher the risk of the loan, and the longer the duration of the loan, the higher yield you should expect to get. It’s worth noting that bondholders take priority (in terms of repayment) over stockholders in the event a company goes bankrupt. There are many bond types. Here are the top four:
Treasury bonds. These are issued by the federal government to finance budget deficits. They are considered to be risk-free since they are backed by the full faith of the U.S. government. Treasuries can have a term of as little as four weeks and as long as 30 years.
Other government bonds. These are issued by other agencies in the government. States and local governments can also issue bonds; these are referred to as municipal bonds.
Investment-grade corporate bonds. These are issued by companies with strong balance sheets and have a low risk of default. Retail investors don’t typically have access to corporate bonds so you would own them through a bond fund (like $VCIT ).
High-yield corporate bonds. These bonds are also known as “junk bonds.” They carry a higher interest rate because they are issued by companies with weaker balance sheets and have a higher risk of default (the entity being unable to pay what they owe). $HYG is the most well-known high-yield corporate bond fund.
Real Estate. Owning property comes in many forms between rentals, flipping, and of course, your house. In fact, 67% of all U.S. household net worth comes from home equity value. Want exposure to real estate without the hassle of owning physical property? Well, a Real Estate Investment Trust (R.E.I.T.) allows you to do that. Some quick facts:
REIT’s are an investment vehicle that you can buy just like a stock. You can invest in an individual “trust” or an ETF that holds a diversified index. For example, $VNQ is the Vanguard Real Estate index and has 168 holdings.
They are required to pay 90% of taxable income to shareholders. Because of this, REIT can pay nice dividends. Sticking with the VNQ example, they pay a 2.91% dividend, based on the current price.
There are many types of REITS, however the main distinction is:
Equity. This captures most REITS. These companies make money from the cash flow and operation of the rental properties they own. Think office buildings, hospitals, apartment buildings, etc.
Mortgage. These REITS purchase mortgages or other mortgage-backed investments and make money from the interest.
Cash or Cash Equivalents. Cash is the most liquid type of asset and can held in a variety of ways, like a money market or savings/checking account.
Commodities. A commodity is a basic good that is used in manufacturing or as an input in the production of other goods and services. Unless you own gold bars, most of these are purchased through financial products rather than the physical asset, for obvious reasons. The prices of these assets have a direct impact on what we pay at places like the gas station and the grocery store. Commodities are highly cyclical, meaning their value is heavily dependent on the economic “cycle” we are in. The opposite of “cyclical” is secular, assets/investments that are marginally impacted by economic trends. For example, Proctor and Gamble ($PG) sells toilet paper and household products. People are still going to need those things even if the economy isn’t doing well. Commodity examples:
Metals (gold, silver, steel, copper, etc.)
Energy (like gold or natural gas)
Agricultural (corn, wheat, etc.)
To illustrate the above point, here’s an example showing the price of a fund that tracks the price of oil, $USO, vs. the aforementioned $PG during the first year of the pandemic. $USO got crushed as all types of travel and industrial production halted across the world (thus demand for oil tanked, pun intended), while $PG was largely unbothered.
Here’s the same chart except in 2021. You can see the opposite effect for $USO as the vaccines came out and travel/industrial production resurged. Many consider commodities to be more trades (short-medium term purchases you make based on a specific catalyst to get in/out) rather than investments (things you hold for the long-term). Commodities can be a great hedge for inflation, a topic I’ll write about soon.
Cryptocurrency. This wasn’t an asset class say five years ago but it deserves inclusion now. This is easily the fastest growing asset class.
There are also non-traditional asset classes, here are a few examples:
Art (I suppose NFT’s fit here too). Companies have done innovative things to allow regular people to access investments that traditionally were reserved for the ultra-wealthy. The appeal to these asset classes is that they are less economically sensitive (i.e. secular) than traditional asset classes. For example, a recession largely isn’t going to impact how much a billionaire is willing to pay for the Mona Lisa. Masterworks does this for art, allowing you to buy “shares” of famous pieces of art.
Wine. Wine has performed incredibly well over the last couple decades, returning ~270%. It’s also the only asset you run the risk of drinking away.
Collectibles. Think sport cards and the things you see on the Pawn Stars tv show.
What’s the bottom-line?
Own assets. You cannot build wealth or make your money work for you without owning assets.
Preview of Part 2:
What determines what types of asset I should seek to own?
What does asset allocation mean and what’s the simplest way to diversify my assets?
How should I think about my risk tolerance?
Wow. This is so informative. I appreciate it Cuz. I was never really taught most of these things in school, and it helps a lot to get a solid foundation of this type of knowledge. I greatly appreciate it!
Great job and great information!