The 5 asset classes to know when you're starting out

Wealth is built from five kinds of things: stocks, bonds, real estate, cash, and a catch-all category called alternative assets. Each one does a different job, and knowing which job is how you stop buying at random. Here are the five, with what they do for you and what they cost you in return.

1. Stocks: the engine

A stock is a small slice of a company. If the company is worth more in ten years, so is your slice. An ETF (exchange-traded fund) is a basket of hundreds of stocks bought in a single trade: instead of choosing between Apple and Shopify, you buy a little of everything.

Over long periods, stocks have returned around 6 to 7% a year on average, after inflation. That is more than anything else on this list, and it is why they carry the growth of a portfolio.

The catch is volatility: sharp, unpredictable rises and falls. A 30% drop comes along roughly once a decade, and it always picks a bad time. That is the price of the return, and it isn't negotiable.

For someone starting out, two or three broad ETFs (Canada, the United States, the rest of the world) inside a TFSA make a perfectly respectable portfolio, and they beat most professional managers over ten years. You can start with $50.

2. Bonds and GICs: the ballast

A bond is a loan you make to a government or a company. They pay you interest, then give your money back on the agreed date. A GIC (guaranteed investment certificate) is the bank version: you lend to your bank for one year or five, at a rate fixed in advance, and the principal is guaranteed.

It earns less than stocks, but it doesn't do roller coasters. When the market drops, bonds often hold, or rise. They are the ballast in the boat: useless in fair weather, precious in a storm.

The bond share grows with age, because the time left to ride out a crash shrinks. At 25, almost none. At 60, close to half. A one-year GIC is also the logical home for money you'll need within twelve or twenty-four months, like a down payment.

3. Real estate: the big one

Your condo, a property you rent out, or a share in a REIT (real estate investment trust, a company that owns buildings and whose shares trade on the stock market like any other).

What makes real estate different is leverage: you control a $500,000 asset with $50,000 of your own and $450,000 of the bank's. If the value rises 5%, you make $25,000 on $50,000 invested. If it falls 5%, the same thing in reverse. Leverage amplifies everything, in both directions.

The costs are heavy: you can't sell a bedroom to pay for a car repair, buying and selling fees run into the tens of thousands, and everything depends on your city's market. For most people, the home they live in is both their biggest asset and their biggest debt, at the same time.

4. Alternative assets: the small pocket

Everything that doesn't fit the three boxes above: crypto, gold, stakes in private companies, and more recently farmland or art. Their appeal is that they don't always move with the stock market. Their flaw is that they move a lot, in every direction, and the tax side is messier (crypto gains are taxable in Canada, even though nobody sends you a slip).

A pocket of 5 to 15% of the portfolio is a sensible ceiling: enough to cheer if it climbs, not enough to cry if it falls.

5. Cash: the cushion

Your chequing account, your savings account, a three-month GIC. It earns almost nothing, and that's fine: the job of cash isn't to earn, it's to be there. A car repair, a lost job, a forced move: without a cushion, the only option is to sell investments at the worst possible moment.

The usual rule: three to six months of expenses in a high-interest savings account. Beyond that, idle money loses the race against inflation. At 3% a year, $10,000 left in a chequing account is worth $7,400 of purchasing power ten years later.

How they fit together

The mix depends mostly on how much time you have. The longer it is, the more market drops you can sit through, so the bigger the stock share can be. Two common splits, as examples:

Real estate isn't in those bars because it doesn't come in $100 increments: you have none, then a whole condo. When it arrives it often outweighs everything else combined, which is one more reason to keep the rest simple.

What you can do right now

Look at what you already have, class by class. Plenty of people discover they are 80% cash and wonder why nothing moves. The simplest way to see it is to work out your net worth once a month, noting each item. The mix gets corrected one transfer at a time.