401k Investments: Understanding What Goes Where
It’s common to hear that people are pursuing either a risky or conservative portfolio, but what really goes into these ideologies? A portfolio, for example your 401(k) account, is composed of different asset classes that work together to limit the risk of one another. There are three main asset classes that people tend to consider when making up their portfolio. These are equities, fixed income, and cash equivalents.
There are a variety of different investments that fall under this category, but the most notable one is common stock. These are the stocks that you hear about on the major stock exchanges such as the Dow Jones Industrial Average or the S&P 500. Some other investments that fall into this class are Real Estate Investment Trusts (REITs), stocks in emerging markets, and high dividend stocks. These assets are considered the riskiest of the classes and are often a key aspect of a risky portfolio.
More commonly referred to as bonds, these investments are of much lower risk and are good for mitigating the risk that some equities give. Bonds give a payment periodically based off of a fixed rate and payment schedule. Most commonly we hear about the US Treasury Bond, which is a fixed term investment that is backed by the US government. This type of investment is virtually risk free due to its connection to the federal government. One can also invest in bonds that are provided by public companies like McDonald’s or Walmart.
These are the most liquid of the asset classes. In addition to cash itself, this class also consists of things that can be turned into cash very quickly such as short term bonds and treasury bills. Due to a fairly low return, these are not common in a risky portfolio. However, investments in cash equivalents rise when markets turn negative due to their low volatility.
Alternative Asset Classes:
In addition to the three main asset classes, many portfolios include what are referred to as alternative assets. These assets include, but are not limited to commodities, hedge funds, and infrastructure. Alternative assets don’t tend to be used for short-term investors due to their general lack of liquidity. Instead, they are used by investors who possess a long-term goal and are willing to wait for significant return.
Understanding these asset classes can help you make more knowledgeable investments based on your goals and desired risk. Without really understanding what’s going into your portfolio, it’s easy to take a gamble instead of a calculated risk.
As always, If you have any questions please contact me at firstname.lastname@example.org or 315-438-4985.
-Tom Brown, CRPS®
Blue Water Capital Management