What’s in Your Portfolio? The Role of Various Asset Classes
What’s in your portfolio?
Ideally, it contains an appropriate blend of investments from various asset classes, such as stocks, bonds, and gold. Each of these plays a unique role in your portfolio, providing the potential for growth, income, relative stability, or inflation protection. By adjusting how much you own of each asset class, you can adjust the risk/reward potential in your portfolio to create a mix that suits your goals and time horizon.
For example, if your investing goal is many years away, giving you room to handle temporary market swings (that is, you have enough risk capacity), and you can stomach those big moves (risk tolerance), your portfolio might be tilted toward growth assets, such as stocks. On the other hand, if you’ll need money from your portfolio soon, or you want less volatility in your portfolio, it might be tilted toward defensive assets, which could include cash, cash investments, and short-term U.S treasuries, which are typically less volatile than stocks and long-term bonds.
Below is a brief overview of major asset classes and what they can bring to your portfolio. Although we’ve grouped them based on how they’re commonly used—for growth, defense, income, or inflation protection—keep in mind that most can fill multiple roles in a portfolio. Note that we’ve also ranked them according to their relative volatility as part of a broader portfolio, from the relatively riskier growth assets to defensive assets aimed at helping manage risk. (For more information about each of these asset classes, check out The Guide to Asset Classes by the Schwab Center for Financial Research.)
Source: Schwab Center for Financial Research. For illustrative purposes only.
Investors typically depend on stocks for growth potential over the longer term. Historically, equities have delivered the highest returns—but with correspondingly higher risk of volatility and losses.
- U.S. large-company (or “large-cap”) stocks are publicly traded shares issued by U.S.-based companies with a market capitalization value of more than $20 billion. Large-cap companies are generally found in the leading U.S. stock indexes, including the S&P 500® and Dow Jones Industrial Average. They tend to be relatively stable and liquid compared with other types of stocks.
- U.S. small-company (or “small-cap”) stocks are shares issued by U.S.-based companies that have a relatively small market capitalization value; companies with a market cap of $2 billion or less are often considered small-caps. Small-cap stocks provide more potential room for growth than large caps, but with commensurately higher volatility.
- International developed large-company (or “international developed large-cap”) stocks are issued by large-cap companies based in countries considered to be highly developed in terms of their economy and capital markets, such as Japan or Germany. They typically provide growth potential and diversification.
- International developed small-company (or “international developed small-cap”) stocks are issued by small-cap companies in developed markets. They offer greater potential for growth than their large-cap counterparts. They also provide diversification in a portfolio that includes U.S. stocks, because the revenues of these companies tend to be tightly tied to their home countries.
- International emerging-market stocks offer higher growth potential than developed markets, because corporate revenues have the potential to grow faster when economic growth is higher. They also offer diversification, as international emerging markets can perform differently than developed markets.
Growth and income
High-dividend-paying stocks and yield-oriented securities can provide both growth and income, given their potential for both high returns and yield. However, they have various levels of risk, and some may experience significant price declines. Also, as noted above, international investments are subject to factors including currency fluctuations and political instability.
- U.S. high-dividend stocks are shares of U.S. companies that tend to distribute higher-than-average dividends to shareholders. They can provide both income and growth potential to a portfolio.
- International high-dividend stocks can provide income, growth, and diversification to a portfolio.
- U.S. real estate investment trusts (REITs) are publicly traded real-estate related securities. REITs typically invest in commercial properties, such as shopping centers and office buildings. They are required by the IRS to pay out at least 90% of their taxable income to unit holders each year, money that is often exempt from corporate income taxes. REITs can provide income potential, inflation protection, and diversification.
- International REITs are REITs in countries outside the U.S. They can provide inflation protection, income potential, and diversification.
- Master limited partnerships (MLPs) are publicly traded securities of partnerships that generate at least 90% of their income from activities related to real estate or the production of oil, natural gas, coal, and other commodities. MLPs offer a tax advantage to investors, as cash flows are not taxed at the company level. MLPs can provide income and growth potential.
A broad array of fixed income investments can provide income. Having a steady stream of income in a portfolio—the kind that fixed-rate coupon payments can provide—can help stabilize a portfolio during a stock market downturn. However, income-oriented investments offer various levels of risk, and aren’t immune to sharp price declines. We’ve ranked them in order of relative level of income and potential volatility:
- Investment-grade municipal bonds are issued by cities, states, counties, and public-purpose entities like hospitals and airports. They generally have relatively high credit ratings and provide income that is typically exempt from federal taxes, making them particularly attractive to investors in high tax brackets who are investing in taxable accounts.
- U.S. securitized bonds include asset-backed securities (ABS), mortgage-backed securities (MBS), and commercial MBS. They are typically backed by hard assets or loans.
- U.S. investment-grade corporate bonds are debt securities issued by U.S. companies with relatively high credit ratings. They tend to offer higher yields than comparable-maturity U.S. Treasury bonds.
- U.S. high-yield corporate bonds, sometimes known as “junk” bonds, are issued by companies with lower credit ratings. Because these bonds are riskier, they typically offer higher yields than comparable investment-grade bonds.
- Bank loans are loans that banks make to commercial borrowers, which are then sold to investment vehicles like mutual funds and exchange-traded funds (ETFs). They typically pay a floating rate based on a short-term interest rate benchmark. Although many investors buy them for income, because of their floating rate they can also be used as a hedge against interest rate changes.
- Preferred stocks have characteristics of both stocks and bonds. They generally offer relatively high yields, which can add income potential to a portfolio.
- International emerging-market bonds are issued by governments and companies in emerging-market countries. They typically offer higher yields to compensate for risk factors such as political instability and currency fluctuations. They can be a source of income and diversification, and offer the potential for capital appreciation.
Inflation protection can minimize the corrosive impact of inflation on the value of your investment, though it’s probably best to think of such investments as offering diversification against inflation, and not a guarantee to keep pace or to beat inflation over time. Inflation-protected bonds and commodities are two such investments. However, keep in mind that inflation-protected bonds could lose value if deflation were to occur, that commodity prices are often volatile, and that futures trading is risky and not suitable for all investors.
- U.S. inflation-protected bonds—called Treasury Inflation-Protected Securities, or TIPS—are used to protect against rising inflation. At maturity, TIPS pay either the inflation-adjusted principal or the original principal, whichever is higher.
- Commodities—such as energy, agriculture, industrial metals, and livestock—can provide both diversification and inflation protection to a portfolio. Investors typically don’t purchase the actual commodity, but invest in mutual funds or ETFs that buy and sell futures contracts, which are agreements to purchase a certain amount of a commodity at an agreed-upon price and date in the future.
Defensive assets generally have low correlations—that is, they don’t move in tandem—with stocks. This means they tend to perform relatively well when the stock market is under pressure—but they may underperform when the stock market is rising. Note that while defensive assets can lessen the impact of volatility on a portfolio, the portfolio may still lose value. Also, international investments and commodities such as gold may be affected by currency fluctuations, geopolitical events, and other factors.
- Cash and cash investments can offer a high level of stability, as well as liquidity and flexibility when needed. Nominal returns also generally rise if interest rates and inflation increase. Cash includes money in bank checking accounts, savings accounts, and certificates of deposit (CDs), which are all insured by the Federal Deposit Insurance Corporation (FDIC).1 Cash also includes money in brokerage accounts, which is protected by the Securities Investor Protection Corporation (SIPC),2 and money in a purchased money fund,3 which isn’t insured, but may offer relatively higher yields than the other cash investments.
- U.S. Treasury securities including Treasury notes and bonds are considered a relatively safe, defensive asset class. Their timely payment of principal and interest is backed by the full faith and credit of the U.S. government, making them among the highest-credit-quality investments available. U.S. Treasuries with shorter maturities can be a useful investment for money that could be needed soon, and Treasuries with longer-maturities can provide diversification to stock investments.
- International developed-country bonds are often considered a defensive asset class that offers U.S.-based investors geographic and currency diversification benefits along with income potential. They can be more volatile, however, than cash, cash investments, and U.S. Treasuries.
- Gold and other precious metals can be used to help buffer a portfolio against inflation and stock market shocks. Historically, when concern about inflation, geopolitical unrest, or financial system stability is high, investors have tended to buy gold. While gold and precious metals may provide defensive attributes, their prices can be volatile, and we don’t suggest them for money that may be needed soon.
1Bank checking accounts, savings accounts, and CDs are insured by the FDIC against the loss of up to $250,000 per depositor, per insured bank, based on account ownership type (e.g., joint accounts) if the FDIC-insured bank were to fail.
2Assets in a brokerage account are protected up to $500,000 per investor, including a maximum of $250,000 in cash, by SIPC, in the event a SIPC-member brokerage fails.
3An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in a money market fund.
- Whether you’re setting up a portfolio for the first time or you’re a seasoned investor, make sure you have the right mix of investments that matches up with your financial goals.
- Consider a robo-advisor, like ®, which can help you build a diversified portfolio across 20 different asset classes selected by a team of Schwab investment experts. Complete a brief to build a portfolio in line with your goals and risk tolerance.
- If you prefer more personalized guidance, consider TM, which combines automated investing with unlimited guidance from a Certified Financial PlannerTM professional.
Investors in money market funds should consider carefully information contained in the prospectus or, if available, the summary prospectus, including investment objectives, risks, charges, and expenses. Please read it carefully before investing.
Please read the Schwab Intelligent Portfolios Solutions™ disclosure brochures for important information, pricing, and disclosures related to the Schwab Intelligent Portfolios and Schwab Intelligent Portfolios Premium programs. Schwab Intelligent Portfolios® and Schwab Intelligent Portfolios Premium® are made available through Charles Schwab & Co. Inc. (“Schwab”), a dually registered investment advisor and broker dealer.
Portfolio management services are provided by Charles Schwab Investment Advisory, Inc. ("CSIA"). Schwab and CSIA are subsidiaries of The Charles Schwab Corporation.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.
Investing involves risk, including risk of loss.
Diversification and asset allocation strategies do not ensure a profit and do not protect against losses in declining markets.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
Small-cap stocks are subject to greater volatility than those in other asset categories.
International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes, and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.
Risks of REITs are similar to those associated with direct ownership of real estate, such as changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and creditworthiness of the issuer.
Investments in securities of MLPs involve risks that differ from an investment in common stock. MLPs are controlled by their general partners, which generally have conflicts of interest and limited fiduciary duties to the MLP, which may permit the general partner to favor its own interests over the MLPs.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower-rated securities are subject to greater credit risk, default risk, and liquidity risk.
Treasury Inflation Protected Securities (TIPS) are inflation linked securities issued by the U.S. government whose principal value is adjusted periodically in accordance with the rise and fall in the inflation rate. Thus, the dividend amount payable is also impacted by variations in the inflation rate, as it is based upon the principal value of the bond. It may fluctuate up or down. Repayment at maturity is guaranteed by the U.S. Government and may be adjusted for inflation to become the greater of the original face amount at issuance or that face amount plus an adjustment for inflation.
Preferred stocks (1) generally have lower credit ratings than the firm’s individual bonds, (2) generally have a lower claim to assets than the firm’s individual bonds, (3) often have higher yields than the firm’s individual bonds due to these risk characteristics, (4) are often callable, meaning the issuing company may redeem the stock at a certain price after a certain date.
Tax-exempt bonds are not necessarily a suitable investment for all persons. Information related to a security's tax-exempt status (federal and in-state) is obtained from third-parties and Schwab does not guarantee its accuracy. Tax-exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.
Commodity related products carry a high level of risk and are not suitable for all investors. Commodity related products may be extremely volatile, illiquid and can be significantly affected by underlying commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions.
Futures trading carries a high level of risk and is not suitable for all investors. Certain requirements must be met to trade futures.
Dividend-focused funds may underperform funds that do not limit their investment to dividend paying stocks. Stocks held by the fund may reduce or stop paying dividends, affecting the fund’s ability to generate income.
Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. For more information on indexes please see www.schwab.com/indexdefinitions.
Correlation is a statistical measure of how two investments have historically moved in relation to each other, and ranges from -1 to +1. A correlation of 1 indicates a perfect positive correlation, while a correlation of -1 indicates a perfect negative correlation. A correlation of zero means the assets are not correlated.
The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.