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In the investment world an asset can be defined as a category of financial instruments that displays similar characteristics.
Bonds are basically an IOU issued by an institution you've lent money to. The institution can be the federal, state or local government, companies, etc. The institution agrees to pay you a set interest rate for a set period of time. At the end of that period of time, they will give you back your principal (the amount you lent them).
Stocks are when you actually own a piece of the company (a shareholder). You typically don't receive interest but hope that your piece of the company will increase in value. For example; you purchase 100 shares of a company's stock at $50 per share for a total amount of $5,000. Say that this $5,000 represents 1% of the total value of the company. In two years the company is now valued at $750,000. Your one percent of the company is now worth $7,5000.
These three assets can be subdivided even further. Bonds can be defined by their length of contract (short term, long term); by the issuer (municipal bonds are issued by state or local governments and government authorities; corporate bonds are issued by companies); by their quality (investment grade, hi-yield (junk)),;their location (international, emerging market).
Stocks can be categorized by the size of the issuing company, i.e., large capitalization, mid-size, small; location, i.e., foreign, emerging market; industry, i.e. technology, services, manufacturing.
Each asset class displays distinct characteristics in how they react to various market conditions. Other asset classes are collectibles (comic books, artwork), precious metals (gold, silver, platinum), and real estate.
Asset allocation involves dividing your portfolio into various asset classes. The emphasis of asset allocation is on preservation of capital - protecting against negative market conditions while still taking advantage of positive conditions. It's believed that the total return of a portfolio is affected more by the asset allocation than by the actual investments themselves.
There are different methods, or approaches, to asset allocation. But that's for another article.
The three most common assets are cash, bonds and stocks. Cash is anything that is liquid or can be easily converted to be liquid. Examples are money, short term government bills, money market accounts, checking and savings accounts.
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