Investment types: Your building blocks for diversification

Open full sized image

Extra baskets for your investment eggs.

© Padraic Spencer—EyeEm/Getty Images

When considering investment types, investors typically think of the big three: stocks, bonds, and cash. Although those traditional assets typically make up a significant chunk of investors’ portfolios, the choice set is wider than you might think.

Beyond traditional investments lie alternative investments—the “everything else” in the investable universe, including commodities, real estate, private debt, and collectibles. Some of these alternatives, such as private equity and digital assets, have become mainstream portfolio components for institutions and individual investors alike.

Investing aims to grow or preserve wealth. The goal of combining different assets and investment types is to target a greater degree of portfolio diversification.

Portfolio diversification is about more than just spreading out your risks to avoid putting all your eggs in one basket. Some economic environments favor different asset types, asset classes, and market segments.

Combining different assets within and across traditional and alternative investment types can help you find that sweet spot between risk and return, in both the short and long term.

The traditional investment category includes stocks, bonds, and cash.

Stocks are shares of publicly traded companies. Each share of stock represents fractional ownership of a company in proportion to the total number of shares available.

As a shareholder, you assume the risks and rewards of a given business. The value of your shares depends on the company’s performance and its prospects for future growth. Stocks are also affected by trends in the economy. Economic growth can lift stock performance, while a recession can pressure stock prices.

Bonds and other fixed-income investments are debt securities issued by governments or corporations. As a bondholder, you’re essentially lending money to the issuer in exchange for regular interest payments and the return of your initial investment at the end of the bond’s life (when the bond “matures”).

Some bonds are more risky than others, so riskier bonds tend to offer higher yields to attract investors. That’s why paying attention to bond credit ratings can be critical. These ratings can help you measure the credit risk of a bond (i.e., the risk that the issuer might default on its obligation to return your money). Credit ratings help you assess the risk versus return of fixed-income investments.

Investors often pair bonds with stocks, because bond prices often rise when the stock market falls (see video below).

Cash is typically not considered an investment unless it’s in an interest-bearing account (such as a savings account or a certificate of deposit). If it’s not earning interest, cash generates zero return, and it can even lose value over time because of inflation. Still, you never know when an investment opportunity might come along, so it’s good to have some cash on hand. Plus, from a personal standpoint, cash can help you get through an emergency.

Alternative investments are non-security or non-cash assets that can appreciate in value. Alternative assets can sometimes carry more risk than traditional assets. And some, like hedge funds, require large amounts of investing capital. Almost all require some degree of specialized knowledge or the guidance of a financial advisor who specializes in alternative assets.

Here are a few of the more common alternative assets:

As an investor, you can purchase individual assets outright or you can invest in a mutual fund or exchange-traded fund that holds your preferred assets within a larger pool of financial instruments.

There are a few advantages to holding a fund versus individual assets:

ETFs can also offer exposure to commodities, crypto futures, inverse and leveraged investment strategies, or specific factors designed to fit your investment profile.

The world of financial investments can be broken down into two general categories: traditional and alternative investment types. If you’re looking to diversify your portfolio, understanding how assets within each category work together can help you build a mix that balances risk and reward.

In today’s markets—where opportunities now extend from index funds to tokenized assets—knowing both traditional and alternative investment types gives you a broader palette for creating a more resilient portfolio.