Financial instruments that display near identical behavioural characteristics on exchanges and in market places, have similar properties and are subject to the same legislative requirements are referred to as an asset class.
Broad Categorisation
Equity instruments, debt instruments, real estate, commodities and cash are the major asset classes. Each such class has sub-categories e.g. equities could be large, medium or small cap. What is important is to remember that each class can be distinguished from another by assessing its liquidity, risk and return
Characteristics
Each class responds variably to market stimuli. Therefore, when the real estate market is down, the commodities market may be booming. Because of this variable behaviour, in response to the same stimuli, experts advocate diversification of investment portfolios.
Importance
Investors should look to broad base their portfolio is such a way that the needs of liquidity, return and investment risk are balanced. This equilibrium could be achieved by distributing investments across classes keeping in mind near term requirements, future plans and provision for contingencies (unexpected events). There is no one-size-fits-all theorem. Much will depend upon investible surplus, investor specific plans and risk appetite.
Analysis for a specific period may reveal that one asset class has performed better than others. But, over varying parcels of time, different classes display superior results. For stability of returns, allocation of investible surplus into different asset classes is advisable.
