Digging Deeper Into Stocks: Part 1

We’ve spent a lot of time on stocks because, as an investor, it will be one of the main types of investments in your portfolio. And I’ve said that stocks are a main asset class, which means stocks generally share many characteristics and tend to behave similarly.

Not All Stocks Are Created Equally

All of that is absolutely true, but it’s also like saying all fruit is the same. Sure, looking at all foods, you know if two things are classified as fruit they’re going to look and taste much more similar to each other than these other two foods categorized as meat. So, it’s important to know if this is fruit or if this is meat. That’s a valuable bit of information, especially if you’re a vegetarian.

But, wow! There are so many different kinds of fruit. Sure, they share similar characteristics, but come on. You have oranges and grapefruit and tangerines over here, and then you have cantaloupe, honeydew, and watermelons over there. All fruit, yes. But there are big differences between an orange and a watermelon, no?

This is why we break our fruit down into smaller sub-categories, such as citrus and melons. We don’t just arbitrarily do this. Fruits within each of these sub-categories have similar characteristics. There’s a reason we group oranges, lemons, and limes together.

Stocks generally share similar characteristics. How can you break them down further?

Back to stocks! Generally, stocks have similar characteristics. Got it. Check. Now let’s break them down further into sub-categories, or what we call sub-asset classes.

But where do we begin?! I don’t know. I mean, you have all these different types of companies all over the world. How are we supposed to start? Hmm, well, I guess we could do it first by geography. If we did that, we’d have U.S. companies in one category and then stock from companies not in the U.S. in an international category. That works. But there’s a big difference between a company headquartered in Switzerland and a company in Cambodia. Nothing against Cambodia – I’ve been several times and it’s a wonderful country with wonderful people. Switzerland has a stable and big economy and government. Cambodia is not as established and their economy is not as big or stable. If there was only a way we could distinguish between the more developed countries and those countries that are more emerging. It would be helpful to know if I’m investing in one of these developed international countries or in one of the not quite as developed but emerging countries. Eureka! I’ve got it. We could call them Developed and Emerging.

Stock Sub-Asset Classes

So, for stocks, we now have three sub-asset classes: U.S., developed international, and emerging international. Again, these are not arbitrary categories. Each of these sub-asset classes has similar characteristics. We don’t just randomly make up these categories; we do it with a purpose. We want to be able to understand how our portfolio might perform under different conditions. It’s helpful if we know we have 100% to U.S. stocks compared to 100% to emerging market stocks. That is a meaningful distinction.

The proceeding blog post is an excerpt from Get Money Smart: Simple Lessons to Kickstart Your Financial Confidence & Grow Your Wealth, available now on Amazon.