10 Types of Investments (and How They Work)
By: Ben Geier, CEPF®
Investing intimidates a lot of people. There are numerous 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 are serious about investing, it might make sense to find a financial advisor to guide you
Stocks may be the most well-known and simple type of investment. When you buy stock, you are buying an ownership stake in a publicly traded company. Many of the biggest companies in the country — think General Motors, Apple, and Facebook — are publicly traded, meaning you can buy stock in them.
When you buy a stock, you are hoping that the price will go up so you can then sell it for a profit. The risk, of course, is that the price of the stock could go down, in which case you would lose money.
Brokers sell stocks to investors. You can either opt for an online brokerage firm or work face-to-face with a broker.
When you but 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. The U.S. Treasury issues Treasury bonds, notes, and bills, all of which are debt instruments that investors buy.
While the money is being lent, the lender gets interest payments. After the bond matures — that is, you have held it for the contractually determined amount of time — you get your principal back.
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, notes, and bills, however, are considered a very safe investment.
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 securities in which to put investors’ money. Fund managers often try to beat a designated market index by choosing investments that will outperform such an index. A passively managed fund, also known as an index fund, simply tracks a major stock market index like the Dow Jones Industrial Average or the S&P 500. Mutual funds can invest in a broad array of securities: equities, bonds, commodities, currencies and derivatives.
Mutual funds carry many of the same risks as stocks and bonds, depending on what they are invested in. The risk is often lesser, though, because the investments are inherently diversified.
Exchange-Traded Funds (ETFs) are like 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, shares of ETFs are bought and sold on the stock markets. Their price fluctuates throughout the trading day, whereas mutual funds’ value is simply the net asset value of your investments, which is calculated at the end of each trading session.
ETFs are often recommended to new investors because they are more diversified than individual stocks. You can further minimize risk by choosing an ETF that tracks a broad index.
Certificates of Deposit
A certificate of deposit (CD) is a very low-risk investment. You give a bank a certain amount of money for a predetermined amount of time. When that time is over, you get your principal back, plus a predetermined amount of interest. The longer the loan period, the higher your interest rate.
There are no major risks to CDs. They are FDIC-insured up to $250,000, which would cover your money even if your bank were to collapse. That said, you must make sure you won’t need the money during the term of the CD, as there are major penalties for early withdrawals.
There are several types of retirement plans. Workplace retirement plans, sponsored by your employer, include 401(k) plans and 403(b) plans. If you don’t have access to a retirement plan, you could get an individual retirement plan (IRA), of either the traditional or Roth variety.
Retirement plans are not a separate category of investment, per se, but a vehicle for making investments, including purchasing stocks, bonds and funds, that exempt you from taxes in one of two ways: either letting you invest pretax dollars (as with a tradition IRA) or allowing you to withdraw money without paying taxes on that money. The risks for the investments are the same as if you were buying the investments outside of a retirement plan.
An option is a somewhat more complicated way to buy a stock. When you buy an option, you are purchasing the ability to buy or sell an asset at a certain price at a given time. There are two types of options: call options, for buying assets, and put options, for selling options.
The risk of an option is that the stock will decrease in value. If the stock decreases from its initial price, you lose your money. Options are an advanced investing technique, and retail should exercise caution before using them.
Many people use annuities as part of their retirement savings plan. When you buy an annuity, you purchase an insurance policy and, in return, you get periodic payments.
Annuities come in numerous varieties. They may last until death or only for a predetermined period. They may require periodic premium payments or just one up-front payment. They may be linked partially to the stock market or they may simply be an insurance policy with no direct link to the markets. Payments may be immediate or deferred to a specified date. They may be fixed or variable.
While annuities are fairly low risk, they aren’t high growth. They make a good supplement to retirement savings, rather than an integral source of funding.
Cryptocurrencies are a fairly new investment option. Bitcoin is the most famous cryptocurrency, but there are countless others, such as Litecoin and Ethereum. Cryptocurrencies are digital currencies that do not have any government backing. You can buy and sell them on cryptocurrency exchanges. Some retailers will even let you make purchases with them.
Cryptos often have wild fluctuations, making them a very risky investment.
Commodities are physical products that you can invest in. They are common in futures markets where producers and commercial buyers – in other words, professionals – seek to hedge their financial stake in the commodities. Retail investors should make sure they thoroughly understand futures before investing in them. Partly, that’s because commodities investing runs the risk that the price of a commodity will move sharply and abruptly in either direction due to sudden events. For instance, political actions can greatly change the value of something like oil, while weather can impact the value of agricultural products.
There are four main types of commodities:
Metals – this includes precious metals like gold and industrial metals like copper
Agricultural – this includes wheat, corn, and soybeans.
Livestock and meat – this includes pork bellies and feeder cattle; and
Energy – this includes crude oil, petroleum products and natural gas
The Bottom Line
There are a lot of types of investments to choose from. Some are perfect for beginners, while others require more experience. Each type of investment offers a different level of risk and reward. Investors should consider each type of investment before determining an asset allocation that aligns with their goals.
Thoughts For Today…
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