10 Types of Investments
Most people know that they should invest if they want their money to outpace inflation over the long run. But it’s easy to get overwhelmed by the sheer volume of investment information that’s available, from 24-hour financial news shows to endless articles on the internet. To cut through all the noise, it’s helpful to think of investments as having one of three types: growth, income, or growth and income. While there is no best investment type for every investor, your own personal financial objectives and risk tolerance will help guide you to what’s best for you within one of these three main classifications. Of course, there are countless types of specific investments within these broad categories. But if you confine your search to these 10 main types of investments, it can help prevent you from being overwhelmed.
When people think about long-term investments, stocks are usually at the top of the list. A share of stock represents ownership in a company. Most well-known companies, from Amazon and Apple to Tesla and Coca-Cola, are publicly traded, meaning you can buy or sell shares of their stock on an exchange. Although supply and demand is what makes the share price of a stock fluctuate from minute to minute, it is the financial success of the underlying business that is one of the primary drivers of a stock’s price. For example, when a company reports booming sales and earnings, investors tend to flood into the market and drive up shares of a stock. But if revenue is below expectations and a company paints a gloomy outlook for the future, investors tend to sell their shares and move on to other investments. This is why it’s important to pick stocks that have good long-term prospects ahead of them.
Bonds are income-generating investments that are generally more conservative than stocks, which is part of the reason their expected return is generally lower. A bond is essentially a loan agreement in which investors provide money to companies in exchange for the promise of ongoing interest payments and the return of their principal at a specified future date. In a perfect world, this would make bonds extremely low risk, and this can indeed be the case. However, bonds are not without risk. If an issuer has financial difficulties, it may not be able to make payments. This is why many bonds carry ratings from outside agencies, to help investors gauge the financial risk of a bond issuer. But bonds also carry interest rate risk due to the fact that bond prices trade down when interest rates rise, and vice versa.
Savings accounts are among the most conservative investments. They don’t offer any opportunity for capital appreciation, but instead guarantee principal protection. Savings accounts are insured by the FDIC up to $500,000, and many banks and brokerages tack on additional insurance to this amount as well. As a result, savings accounts generally have low returns. For example, as of Sept. 8, 2022, the national average savings interest rate was just 0.13% annually. To maximize your returns from a savings account, consider choosing an account at an online bank. With low overhead, these types of banks were offering closer to 2% as of the same date. While savings accounts aren’t generally appropriate for long-term investment goals, they can be excellent choices for short-term savings, such as your emergency fund.
Certificates of Deposit
A certificate of deposit is something of a hybrid between a savings account and a bond. Certificates of deposit have fixed interest rates and maturity dates, like bonds, but they also carry the same FDIC insurance as savings accounts. Generally speaking, CDs pay slightly higher interest rates than savings accounts. However, they also typically have early withdrawal penalties, meaning you shouldn’t invest unless you’re willing and able to tie up your money for a period of time. CDs usually have maturity dates ranging between three months and 10 years, so they do offer some flexibility. Many investors will stagger their CD investments over a number of different maturities using a strategy known as a ladder. For example, an investor might spread out a $10,000 total investment over 10 different CDs, with maturities ranging from 1 year to 10. As the CDs mature, the money can either be used or reinvested at the end of the ladder.
Mutual funds date back to 1924 and have long been a favored investment option by the general public. Under the guidance of professional managers, mutual funds pool money from investors and invest it according to written guidelines. Generally speaking, the objective of a mutual fund is to outperform an index that it tracks. For example, a growth mutual fund might have an objective of beating the return of the S&P 500 index. As mutual funds are generally actively managed, their ongoing expenses can be high. However, the performance of the fund may outweigh the cost of the additional fees. One of the drawbacks of traditional mutual funds is that they may only be bought or sold once per day, at the close of the trading day.
Exchange-traded funds are more of a modern take on traditional mutual funds. Exchange-traded funds typically hold a portfolio of securities but trade on an exchange as a single investment, like a stock. Unlike a traditional mutual fund, an ETF can be bought and sold on an exchange any time the market is open. Exchange-traded funds often have specialized portfolios that track either a specific market index or a specific sector of the market, such as the S&P 500 index or technology stocks. They generally have low annual expenses and may be bought or sold commission-free, depending on the broker you use.
Commodities are physical products like oil, orange juice, pork bellies and gold. An investment in commodities is often considered to be a hedge against inflation, as the prices of these items rise in line with general cost increases. However, commodities trading is dominated by professional traders and institutions, and it can be difficult for general retail investors to participate directly. Commodities can also be extremely volatile, as unexpected events like bad weather, supply chain issues or geopolitical issues can dramatically affect the prices of individual products. There are some mutual funds and ETFs that provide easier access for retail investors to commodities.
Annuities are insurance contracts that provide payments to investors on a regular basis. The main reason to own an annuity is to create an income stream that you can’t outlive. Unlike bonds, which pay off at a specified maturity date, annuities generally continue payments for the remainder of your life.
There are two main types of annuities: fixed and variable. Fixed annuities convert an initial premium into regular income payments, typically at a fixed interest rate. Variable annuities generally have a growth component during an accumulation phase and then convert to income-paying investments during the distribution phase.
The main drawbacks of annuities are their fees and the government penalties that apply to withdrawals before age 59 ½. Before you invest in an annuity, be sure to speak with your financial and tax advisors.
At their most basic level, an option is a financial instrument that grants you the right to buy or sell a stock at a specific price at a date in the future. Options come in many varieties, and professional traders generally use them in a combination of hedging and speculative strategies. While options offer the potential for immense gain, they also carry the risk of the 100% loss of your investment.
For example, let’s say you invest $500 in a call option, which gives you the right to buy a stock at $100 per share in the next three months. If that stock never rises above the specified price, which is known as the strike price, your option will expire worthless. However, if the stock rises significantly above $100, your investment could double or triple, or even more.
Although some more conservative strategies are available using options, they are generally considered speculative investments that are only appropriate for experienced investors.
Cryptocurrency is the newest asset class on this list, and it’s by far the most speculative. In fact, many big-name investors don’t even consider cryptocurrency to be an “asset” but rather a speculative fantasy. Of course, on the other side of the coin are many well-known investment professionals who are making big bets on cryptocurrency. So, what is it exactly, and does it deserve a place in your portfolio?
Cryptocurrency in general is a digital currency that has its transactions recorded on a decentralized, encrypted blockchain. The theory behind crypto is that it offers privacy and reliability beyond current fiat currency systems run by governments the world over.
However, for now, cryptocurrency remains a highly speculative investment. Even Bitcoin, the largest and most well-known cryptocurrency, is down over 58% YTD as of Sept. 8, 2022. The bottom line is that while cryptocurrency may give your portfolio a bounce at some point, the speculative nature of the asset class means you should limit your exposure.
The Bottom Line
Although investing can seem overwhelming at first glance, if you take the time to understand the major types of investments, you’re likely to find some that match your investment objectives and risk tolerance. For some investors, working with a financial advisor is the best way to start, while others may prefer to open their own accounts with online brokerages and learn through experience. Either way, be sure to manage your risk and understand what you are investing in so that you can set yourself up for long-term success.
Information is accurate as of Sept. 8, 2022.