Investing intimidates a lot of people. There are a lot of options, and it can be hard to figure out which investments are right for your portfolio. This guide walks you through 10 of the most common types of investment and explains why you may want to consider including them in your portfolio. If you're serious about investing, it might make sense to find a financial advisor to guide you. Klear Picture can help you find the right advisor for you with our free financial advisor matching service.
The world of investing can often be confusing, so we're here to explain to you the four main types of investments, or asset classes, that you can choose from.
Young investors will often believe that an investor is someone with a whole lot of money, like Berkshire Hathaway's (NYSE: BRK.B) Warren Buffett or Amazon (NASDAQ: AMZN) CEO Jeff Bezos. This couldn't be further from the truth.
As well as that, merely investing in the likes of Apple (NASDAQ: AAPL), Tesla (NASDAQ: TSLA), Virgin Galactic (NYSE: SPCE) or any other publicly-traded company is not the only form of investing. Many analysts believe there are four distinct types of investment, split into two sub-categories, which are:
- Growth investments: Long-term investments in shares or property.
- Defensive assets: Consistently generated income such as cash and bonds.
While we have a primary focus on stock investments here at MyWallSt, it is still essential to know the difference between these four main types.
As an investor, you have a lot of options for where to put your money. It's crucial to weigh the types of investments carefully.
Investments are generally bucketed into three major categories: stocks, bonds and cash equivalents. There are many different types of investments within each bucket.
Think of the various types of investments as tools that can help you achieve your financial goals. Each broad investment type—from bank products to stocks and bonds—has its own general set of features, risk factors and ways in which investors can use them.
The investment landscape can be extremely dynamic and ever-evolving. But those who take the time to understand the basic principles and the different asset classes stand to gain significantly over the long haul. The first step is learning to distinguish different types of investments and what rung each occupies on the "risk ladder."
6 Types of Investments
A cash bank deposit is the most straightforward, most easily understandable investment asset—and the safest. Not only does it give investors precise knowledge of the interest they'll earn, but it also guarantees they'll get their capital back.
On the downside, the interest earned from cash socked away in a savings account seldom beats inflation. Certificates of deposit (CDs) are highly liquid instruments, very similar to cash that are instruments that typically provide higher interest rates than those in savings accounts. However, money is locked up for some time, and there are potential early withdrawal penalties involved.
Cash investments include everyday bank accounts, high-interest savings accounts and term deposits.
They typically carry the lowest potential returns of all the investment types.
While they offer no chance of capital growth, they can deliver regular income and can play an essential role in protecting wealth and reducing risk in an investment portfolio.
We are in the midst of a 'war on cash' according to some, with companies such as Square (NYSE: SQ) and PayPal (NASDAQ: PYPL) set out to end the need for cash as a utility altogether. However, cash will likely always have a place in the economy, whether in paper or digital form.
Cash investments include everyday bank accounts, high-interest savings accounts and term deposits, and typically carry the lowest potential returns of the four different investment types.
However, it is always healthy to have a good amount of cash on hand in case of a rainy day. It is safe, and though it will lose value over time due to inflation, it can play an important role in providing you with liquidity should a downturn occur.
The average bank interest rate for checking accounts in the United States is 0.06%.
Cash equivalent investments protect your original investment and let you have access to your money. Examples include:
- Savings accounts
- Money market accounts
- Certificates of deposit (CDs)
These different types of investments generally deliver a more stable rate of return. But cash equivalent investments aren't designed for long-term investment goals such as retirement. After taxes are paid, the rate of return is often so low that it doesn't keep pace with inflation.
A bond is a debt instrument representing a loan made by an investor to a borrower. A typical bond will involve either a corporation or a government agency, where the borrower will issue a fixed interest rate to the lender in exchange for using their capital. Bonds are commonplace in organizations that use them to finance operations, purchases, or other projects. The interest rates essentially determine bond rates. Due to this, they are heavily traded during periods of quantitative easing or when the Federal Reserve—or other central banks—raise interest rates.
When you buy a bond, you're essentially lending money to an entity. Generally, this is a business or a government entity. Companies issue corporate bonds, whereas local governments issue municipal bonds.
After the bond matures — that is, you've held it for a predetermined amount of time — you earn back the principal you spent on the bond, plus a determined rate of interest. The rate of return for bonds is typically much lower than it is for stocks, but bonds also tend to be lower risk. There is some risk involved, of course. The company you buy a bond from could fold or the government could default. Treasury bonds especially, however, are considered a very safe investment.
A bond is a loan you make to a company or government. When you purchase a bond, you're allowing the bond issuer to borrow your money and pay you back with interest.
Bonds are generally considered less risky than stocks, but they also may offer lower returns. State and city government bonds are generally considered the next-less-risky option, followed by corporate bonds—generally, the less risky the bond, the lower the interest rate. For more details, read our introduction to bonds.
How investors make money: Bonds are a fixed-income investment, because investors expect regular income payments. Interest is generally paid to investors in regular instalments — typically once or twice a year — and the total principal is paid off at the bond's maturity date.
When you buy a bond, you're lending money to a company or governmental entity, such as a city, state or nation.
Bonds are issued for a set period of time during which interest payments are made to the bondholder. The amount of these payments depends on the interest rate established by the issuer of the bond when the bond is issued. This is called a coupon rate, which can be fixed or variable. At the end of the set period of time (maturity date), the bond issuer is required to repay the par, or face value, of the bond (the original loan amount).
Bonds are considered a more stable investment compared to stocks because they usually provide a steady flow of income. But because they're more stable, their long-term return probably will be less when compared to stocks. Bonds, however, can sometimes outperform a particular stock's rate of return.
Keep in mind that bonds are subject to a number of investment risks including credit risk, prepayment risk and interest rate risk.
You can invest in housing and real estate. I like any good Rule #1 investment – Publicly traded businesses, private businesses, apartments, farms and trailer parks are all good as long as you treat them the same as an investment.
The hardest part about investing in real estate is getting a house that is 50% off of what it's worth. If you can do that though, you can make some decent returns investing in real estate.
However, it might be easier to invest in the stock market, make the same returns or better, and not have to deal with having a bunch of rental properties to take care of.
Investors can acquire real estate by directly buying commercial or residential properties. Alternatively, they can purchase shares in real estate investment trusts (REITs). REITs act like mutual funds wherein a group of investors pool their money together to purchase properties. They trade like stocks on the same exchange.
You can invest in mutual funds. A mutual fund is a pool of funds from many investors that are diversified into many different things, including, stocks, bonds, and other assets.
They're operated by money managers who invest your money for you and attempt to get good returns. There are A TON of downsides.
The biggest one being that most mutual funds don't actually make positive returns, but you still have to pay the money manager a percentage of your money.
A mutual fund is a type of investment where more than one investor pools their money together in order to purchase securities. Mutual funds are not necessarily passive, as they are managed by portfolio managers who allocate and distribute the pooled investment into stocks, bonds, and other securities. Individuals may invest in mutual funds for as little as $1,000 per share, letting them diversify into as many as 100 different stocks contained within a given portfolio.
Mutual funds are sometimes designed to mimic underlying indexes such as the S&P 500 or DOW Industrial Index. There are also many mutual funds that are actively managed, meaning they are updated by portfolio managers who carefully track and adjust their allocations within the fund. However, these funds generally have greater costs—such as yearly management fees and front-end charges—which can cut into an investor's returns.
Mutual funds are valued at the end of the trading day, and all buy and sell transactions are likewise executed after the market closes.
A mutual fund is a pool of many investors' money that is invested broadly in several companies. Mutual funds can be actively managed or passively managed. An actively managed fund has a fund manager who picks companies and other instruments in which to put investors' money. Fund managers try to beat the market by choosing investments that will increase in value. A passively managed fund tracks a primary stock market index like the Dow Jones Industrial Average or the S&P 500. Some mutual funds invest only in stocks, others only in bonds and some in a mixture of the two.
Mutual funds carry many of the same risks as stocks and bonds, depending on what they are invested in. The risk is lesser, though, because the investments are inherently diversified.
Invest in the Stock Market
Shares are considered a growth investment as they can help grow the value of your original investment over the medium to long term.
If you own shares, you may also receive income from dividends, which are effectively a portion of a company's profit paid out to its shareholders.
Of course, the value of shares may also fall below the price you pay for them. Prices can be volatile from day to day, and shares are generally best suited to long term investors, who are comfortable withstanding these ups and downs.
Also known as equities, shares have historically delivered higher returns than other assets; shares are considered one of the riskiest types of investment.
And finally, the investing type we all know and love shares. Whether you're a fan of the safe and solid Microsoft (NASDAQ: MSFT) or the risky, potentially high growth Beyond Meat (NASDAQ: BYND), investing in shares allows you to take a slice of either.
As I'm sure you are already aware of how investments in company shares work, I'll keep this brief:
Shares are considered a growth investment as they can help grow the value of your original investment over the medium to long term. If you own shares, you could also receive income from dividends, which is when a company shares a portion of their profits with investors.
Companies sell shares of stock to raise money for start-up or growth. When you invest in stocks, you're buying a share of ownership in a corporation. You're a shareholder.
There are two types of stock:
- Common stock. Shareholders have a percentage of ownership, have the right to vote on issues affecting the company and may receive dividends.
- Preferred stock.
Investment returns and risks for both types of stocks vary, depending on factors such as the economy, political scene, the company's performance and other stock market factors.
Shares of stock let investors participate in the company's success via increases in the stock's price and through dividends. Shareholders have a claim on the company's assets in the event of liquidation (that is, the company going bankrupt) but do not own the assets.
Holders of common stock enjoy voting rights at shareholders' meetings. Holders of preferred stock don't have voting rights but do receive preference over common shareholders in terms of the dividend payments.
Exchange-Traded Funds (ETFs)
Exchange-traded funds (ETFs) have become quite popular since their introduction back in the mid-1990s. ETFs are similar to mutual funds, but they trade throughout the day, on a stock exchange. In this way, they mirror the buy-and-sell behaviour of stocks. This also means their value can change drastically during the course of a trading day.
ETFs can track an underlying index such as the S&P 500 or any other "basket" of stocks the issuer of the ETF wants to underline a specific ETF with. This can include anything from emerging markets, commodities, individual business sectors such as biotechnology or agriculture, and more. Due to the ease of trading and broad coverage, ETFs are extremely popular with investors.
Exchange-traded funds (ETFs) are similar to mutual funds in that they are a collection of investments that tracks a market index. Unlike mutual funds, which are purchased through a fund company, ETFs are bought and sold on the stock markets. Their price fluctuates throughout the trading day, whereas mutual funds' value is simply the net value of your investments.
ETFs are often recommended to new investors because they're more diversified than individual stocks. You can further minimize risk by choosing an ETF that tracks a broad index.
ETFs are a type of index fund: They track a benchmark index and aim to mirror that index's performance. Like index funds, they tend to be cheaper than mutual funds because they are not actively managed.
The major difference between index funds and ETFs is how ETFs are purchased: They trade on an exchange like a stock, which means you can buy and sell ETFs throughout the day and an ETF's price will fluctuate throughout the day. Mutual funds and index funds, on the other hand, are priced once at the end of each trading day — that price will be the same no matter what time you buy or sell. Bottom line: This difference doesn't matter to many investors, but if you want more control over the price of the fund, you might prefer an ETF. Here's more about ETFs.
How investors make money: As with a mutual fund and an index fund, your hope as an investor is that the fund will increase in value and you'll be able to sell it for a profit. ETFs may also pay out dividends and interest to investors.
Investment education is essential—as is avoiding investments you don't fully understand. Rely on sound recommendations from experienced investors, while dismissing "hot tips" from untrustworthy sources. When consulting professionals, look to independent financial advisors who get paid only for their time, instead of those who collect commissions. And above all, diversify your holdings across a wide swath of assets.
Put your money into the only type of investment that's guaranteed to make you money—the stock market.