Understanding Different Asset Types

Stocks represent ownership in a company and a claim on its future profits. As a company’s perceived value rises and falls, the value of its stock can move up and down, too.

Stocks, or equities, can experience bouts of short-term volatility. They have, however, historically provided higher long-term returns than nearly every other asset class. Think of higher short-term volatility as the “price” investors must pay for stocks’ higher potential long-term returns. This can be important if your financial goals require long-term growth.

A bond is effectively a loan an investor makes to an issuer. The issuer can be a company, government or other entity. The investors, or bondholder, lends the issuer the face value of the bond for a stated time, or “contract period.”

The issuer promises to repay the face value of the bond, plus interest. At regular intervals, the issuer makes interest payments to the bondholder.  The issuer then repays the face value amount, or principal, at the end of the contract period.

Bonds, or “fixed income,” generally provide lower short-term volatility than stocks. Lower volatility can mean relatively lower potential long-term returns. This characteristic may make bonds more appropriate for investors with shorter time horizons or specific cash needs.

Mutual funds are investments vehicles that pool money from various investors. A wide variety of mutual funds exist, all with their own fees and costs. Mutual funds can be a convenient way to invest. Investors, though, must accept that they have no control over the fund’s investment selections.

Also, the lack of personal customization means large portfolios could be sacrificing returns and tax efficiency when they hold mutual funds in a retirement account.

Exchange-traded funds (ETFs) work much like mutual funds. They pool investors’ money to build a diversified portfolio of stocks, bonds or other securities. Many ETFs seek to mirror the performance of a particular index, sector or asset class.

ETFs offer the potential for affordable diversification. That can be especially true for investors with smaller portfolios. The lack of personalization and the risk of overdiversification, however, are potential drawbacks of ETFs.