When constructing your portfolio, you will want to consider variety of asset classes that match with your investment objective. An asset class is a collection of securities, which possess similar characteristics, behave similarly in the market and are subject to the same laws and regulations.
Core asset classes are commonly consists of cash equivalents or money market instruments, fixed income, and equity. You may include other asset types beyond the core classes in your investment; some investment professionals would add real estate and commodities as alternative investments.
Each asset class has different risk and return investment characteristics, and will perform differently in any given market environment.
Cash Equivalents (Money Market Instruments) are investment securities that are short-term, have a low-risk, low-return profile and are highly liquid. Money market instruments are considered as a unique asset class commonly used in building an investment portfolio as they have distinct risk and return characteristics from other asset classes. Cash equivalents include U.S. government Treasury bills, bank certificates of deposit, bankers' acceptances, commercial paper and other money market instruments.
Bonds, commonly referred to as fixed-income securities, are debt investments in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. Interest on bonds is usually paid every six months (semi-annually). The annual return rate that the bond will pay is usually referred to as the yield of the bond. The entity returns the investor's principal at the maturity. Companies, municipalities, states and U.S. and foreign governments use bonds to finance a variety of projects and activities. Before maturity, the value of fixed-income investments can fluctuate in response to current interest and inflation rates. Bonds are generally less risky assets than equities (their variance of returns has been lower over time) but produce lower rates of return.
Stock is an instrument that signifies an ownership position (called equity) in a corporation, and represents a claim on its proportional share in the corporation's assets and profits. Ownership in the company is determined by the number of shares a person owns divided by the total number of shares outstanding. Most stock also provides voting rights, which give shareholders a proportional vote in certain corporate decisions. Only a certain type of company called a corporation has stock; other types of companies such as sole proprietorships and limited partnerships do not issue stock.
Alternative investment is an investment considered outside of the traditional asset classes of stocks, bonds and cash. Examples of alternative investments include real estate, commodities, options and derivatives. Alternative investments are often used by hedge funds.