Let's first consider the relative performance of stocks and bonds, which historically have shown somewhat of an inverse correlation:
- When the economy is strong and growing, with low unemployment, stocks tend to perform well as consumers spend and corporate profits rise. At the same time, bonds may underperform as interest rates rise to keep track with economic growth and inflation. When inflation is high, fixed-rate bonds may also fare comparatively worse if the coupon rate is below the rate of inflation.
- When the economy is turning sour and recession hits, unemployment rises and people stop spending as much, hurting corporate profits. This, in turn, can weigh down on stock prices. But, as interest rates fall in response to a sagging economy, bonds may outperform.
Most financial professionals recommend a portfolio mix consisting of stocks and bonds, as described above. Other asset classes, too, may favor certain economic conditions; however, not all asset classes are suitable for investors.
- Real estate: A strong economy and low unemployment can lead to a robust housing market, which may benefit real estate investments. However, rising interest rates can put a damper on mortgage borrowing.
- Commodities: Inflationary environments can lead to an increase in the prices of certain commodities, making them a favorable asset class to use as an inflation hedge.
- Alternative investments: Private equity, venture capital, hedge funds, and other non-traditional investments may outperform in an environment of low interest rates and high liquidity. These types of investments, though, are not always available to individual investors and may require a significant outlay of cash and feature lower levels of liquidity.
- Gold: Gold is considered as a safe haven asset and it performs well in times of economic uncertainty, geopolitical tensions and during inflationary environment. This was especially the case during the COVID19 pandemic, which saw gold rise to all-time highs during the Spring of 2020.
- Cash and cash equivalents, (e.g. money market funds and CDs): These also tend to perform relatively well in uncertain or volatile economic environments is because they, too, are considered to be a safe haven. Investors may turn to cash as a way to preserve their capital and limit downside exposure to risk during bear markets. However, in a stable and low-inflation environment, cash will not usually provide returns as high as other asset classes such as stocks or bonds - but the stability and the low risk make a small allocation to cash an attractive option for investors seeking preservation of capital or for short term liquidity needs.
What Are the Different Asset Classes?
Historically, the three main asset classes are considered to be equities (stocks), debt (bonds), and money market instruments. Today, many investors may consider real estate, commodities, futures, derivatives, or even cryptocurrencies to be separate asset classes.
Which Asset Classes Are the Least Liquid?
Generally, land and real estate are considered among the least liquid assets, because it can take a long time to buy or sell a property at market price. Money market instruments are the most liquid, because they can easily be sold for their full value.
What Asset Classes Do Well During High Inflation?
Real estate and commodities are considered to be good inflation hedges, because their value tends to rise as prices increase. In addition, some government bonds are also indexed to inflation, making them an attractive way to store excess cash.
The Bottom Line
Investment education is essential—as is avoiding investments that you don’t fully understand. Rely on sound recommendations from experienced investors, while dismissing “hot tips” from untrustworthy sources. When consulting professionals, look to independent financial advisors who get paid only for their time, instead of those who collect commissions. And above all, diversify your holdings across a wide swath of assets.
