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Investing in Different Asset Classes: The Key To Building a Diversified Portfolio

By 
Austin Ortiz

It has been a wild ride for the equities markets in 2022. Having one of its best months since 2020, the S&P 500 gained 9.1% at the conclusion of July. Although July showed hope for more upside, the S&P 500 is still down 13.6% year-to-date. Additionally, the Federal Reserve has stated that Inflation is still an underlying issue in the economy that must be resolved. Futures pricing indicates a strong likelihood for rate increases to continue for the remainder of the year. 

The equities market has not generated ideal returns for investors, but other markets have shown strength during this stretch of volatility. The commodities market, bond market, real estate market, and other exchange-traded funds and indexes have generated positive returns for investors. A variety of assets have outperformed equity benchmarks like the S & P 500 (INDEXSP: .INX) and Dow Jones Industrial Average (INDEXDJX: .DJI). Investing in assets such as commodities or bonds can help diversify your portfolio during this volatile period in the equities markets. 

What Is Diversification? 

Diversification is the act of investing in a variety of different investments. Money managers and investors diversify their portfolios in order to limit the risk of the underlying portfolio. There is no sole strategy to diversify a portfolio. When diversifying a portfolio, it is important to allocate your capital in a variety of low-correlated or uncorrelated assets to minimize risk and maximize potential returns. 

How To Invest In Different Asset Classes: 

Below are some examples of different asset classes, and how you can invest in them today.

1. Equities 

Investing in equities is the most popular asset class to invest in. Equities, another term for stocks, are shares issued by a company that represent ownership of a company. The current total market capitalization of United States equities is around 44 trillion dollars. Tesla (NASDAQ: TSLA), Apple (NASDAQ: AAPL), and Amazon (NASDAQ: AMZN), are just a few examples of publicly traded equities in the United States. Investing in equities is risky, since a company must perform well to generate returns for its investors. When the economy is strong, equities tend to perform better than most other asset classes. The opposite can be said when the economy is experiencing a decline or limited growth. Indexes and exchange-traded funds also allow individuals to invest in equities with lowered risk. Examples of these are the SPDR S & P 500 ETF Trust (NYSEARCA: SPY), and the Russell 2000 Index (INDEXRUSSELL: RUT). 

2. Commodities 

Commodities are basic goods used in commerce, and interchangeable with other goods. Most commodities are used as raw materials to manufacture other goods or provide a service. The three main groups for commodities are agriculture, energy, and metals. Individuals invest in commodities since they have a lower relative volatility and rarely experience a decline in demand. Investing in commodities is as simple as buying physical gold and silver, or you can invest in an index fund, like the United States Commodity Index Fund (NYSEARCA: USCI). Other exchange-traded funds that revolved around commodities are the United States Oil Fund (NYSEARCA: USO), which tracks crude oil prices, and the Teucrium Corn Fund (NYSEARCA: CORN), which tracks prices for corn futures. Investing in commodities helps individuals diversify their portfolio since prices are less volatile and less correlated to other asset classes.

3. Bonds 

Bonds, also known as fixed income instruments, are financial instruments used by corporations and governments to raise capital. When an individual purchases a bond, he pays an initial investment on the coupon. Individuals generate returns on investments from a bond’s coupon rate, the interest rate set by the issuer of the bond. When corporations and companies issue bonds, there is a specific date that the interest is due to investors, referred to as the maturity date. Investors of bonds receive their principal investment, plus the additional interest on the bonds, by the date of maturity. Bonds allow investors to put money into a less risky financial instrument than equities, while still offering a high potential return. The iShares Core US Aggregate Bond ETF (NYSEARCA: AGG), an exchange-traded fund that tracks a portfolio of United States investment-grade bonds, and the iShares 20 Plus Year Treasury Bond ETF (NASDAQ: TLT), an exchange-traded fund that tracks a portfolio of United States Treasuries expiring in 20 years or more, are both financial instruments used to invest in bonds. Investing in bonds can help lower the volatility of your portfolio, while still generating returns that are more comparable to equities. 

4. Volatility Indexes

 

Volatility Indexes are used to track the expected volatility of equities markets over a specific number of days. Volatility indexes use the implied volatility and prices of S & P 500 index options, to reflect the sentiment of the equities markets. One of the most popular volatility indexes is the VIX (INDEXCBOE: VIX). Typically when the Vix is lower it signifies a less risky equities market, and tends to rise as the market becomes more risky. Volatility indexes typically spike during times of turmoil or extreme uncertainty. Individuals invest in volatility indexes because they generally are inversely correlated to United States equity benchmarks. Investing in volatility indexes helps investors diversify their portfolio, and can produce massive returns during bear markets.

5. Real Estate 

The real estate market is used by individuals to purchase, manage, and sell or rent property. Investing in real estate allows individuals to generate passive income over the short-term, while also leaving the possibility of generating larger returns in the long-term. Investing in property can be expensive and usually is inaccessible for most investors, but there are cheaper alternatives to add real estate investment vehicles to your portfolio. Most commonly, Real Estate Investment Trusts, “REITS”, are financial instruments that trade similarly to stocks and are composed of income-producing real estate assets. Examples of Real Estate Investment Trusts are the Vanguard Real Estate ETF (NYSEMKT: VNQ), and iShares U.S. Real Estate ETF (NYSEMKT: IYR). Both are exchange-traded funds that allow individuals to invest in cash-flowing commercial real estate. Real Estate Investment Trusts have historically produced solid returns, commonly pay dividends, and provide supplemental diversification. 

Diversify Your Portfolio Today 

As uncertainty continues to loom in the financial markets, it is vital to have a well-diversified portfolio. Investing in a variety of asset classes helps diversify your portfolio, minimizing downside during volatile, bearish markets, while still helping you generate positive returns in less-volatile market conditions. Diversification is the key to building a sustainable portfolio over the long-term. Invest in different asset classes today to help you achieve your financial goals. 

Learn more at Alinea Invest.

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