Where the money goes
Stand back from individual stocks for a moment and look at the broader landscape. All of investable wealth flows into one of a handful of asset classes — broad categories of investments that share key characteristics. Knowing the categories is more useful than knowing individual securities, because asset class is what drives most of your portfolio's behavior.
The big four:
Stocks (equities)
Ownership stakes in companies. You own a slice; you participate in the company's growth (or decline). Returns come from price appreciation + dividends. Higher historical return than other major asset classes (~7-10% real per year long-term in the US), but also higher σ (15-20% annually for the broad market, more for individual stocks).
Subclasses: by size (large-cap, mid-cap, small-cap), by region (US, developed international, emerging markets), by style (value vs. growth), by sector (tech, healthcare, financials, etc.).
Bonds (fixed income)
Loans you make to issuers (governments or companies). They pay you interest (coupons) and return your principal at maturity. Returns are mostly known in advance — a 10-year bond at 4% coupon will pay you 4% per year for 10 years and then return face value. Lower σ than stocks (5-10% for investment grade).
Subclasses: by issuer (government vs. corporate), credit quality (investment grade vs. high yield/junk), maturity (short, intermediate, long-term), inflation-protected (TIPS).
Cash and cash equivalents
Money in checking/savings accounts, money market funds, T-bills. σ is essentially zero. Returns track the risk-free rate r_f from last lesson — usually 0-5% per year depending on the era. Liquid, safe, but loses purchasing power to inflation.
Alternatives
Everything that isn't stocks, bonds, or cash. Real estate (REITs or direct), commodities (gold, oil, agricultural products), private equity, hedge funds, collectibles, crypto. Some have low correlation with stocks/bonds (good for diversification), but they vary wildly in σ and liquidity. Track 9 returns to alternatives briefly.
Why asset class matters more than picking individual securities
Studies of long-term portfolio performance consistently find that asset allocation (how much you put in stocks vs. bonds vs. cash) explains most of the variation in returns across portfolios. Picking individual stocks within an asset class matters too, but it's the smaller knob.
This is why "60/40" (60% stocks, 40% bonds) became a default for decades. Two asset classes, mixed in a sensible proportion, captured most of what most investors needed. Whether 60/40 still makes sense in any given era is a separate debate; the principle (asset allocation matters more than security selection) holds.
The takeaway
Four big asset classes: stocks, bonds, cash, alternatives. Each has its own risk-return profile and reacts differently to macro conditions. The mix of asset classes (asset allocation) drives most of a portfolio's behavior. Picking individual securities within a class is a smaller (though not zero) lever. Track 9 explores allocation in detail.
