What are the different types of investments?
The world of investments can seem scary due to the abundance of choices. So, which ones are right for you? How do you even start to put a portfolio together? Here we take a look at ten of the most common types of investment and consider the advantages they might bring.
1. What are stocks and shares?
Stocks and shares—sometimes known as equities—are the best-known and most straightforward kind of investment. Here, you’re buying a stake in a publicly traded company. These companies include some of the biggest names out there, such as Apple and Microsoft.
Although bonds are a low-risk investment, the returns tend to be lower too. There is still some risk, however, as the company you have bought a bond from could go bust, or the government might default. If you have a low tolerance to risk, Treasury bonds are considered very safe investments.
3. What is a mutual fund?
A mutual fund is where a group of investors pool money in a variety of companies. The funds can then be managed in two ways. Active management means having a fund manager, who will choose securities in which to put your money. They will often try to beat a designated market index – such as the S&P 500 or Dow Jones – by choosing investments that will outperform the index.
If your fund is passively managed, it simply tracks a major stock market index.
You can make money from a mutual fund when stocks, bonds, and other securities go up. The risk is roughly like investing in stocks and shares, but lower because the investments are spread wider.
4. What are exchange-traded funds (ETFs)?
ETFs are like mutual funds in that they are a collection of investments that track a market index. The difference is that ETFs are bought and sold on the stock market, so their prices go up and down throughout each trading day. Mutual fund values are calculated once at the end of each trading session.
ETFs generate money through the collection of returns from all their investments. They are a good bet for beginners because your investment – and risk – is spread when compared with individual stocks.
5. What are certificates of deposit (CDs)?
Here’s a very low-risk investment type. Quite simply, you give a bank money for an agreed period of time and earn interest on it. Once the agreed time is up, you get your principal back – your original amount – plus a predetermined amount of interest. The longer the loan period, the greater the interest accrued is likely to be, but the potential returns are low.
You will make some money in interest – especially if you take a long-term view. The risks involved are also negligible because banks are insured by the Federal Deposit Insurance Corporation (FDIC), so if the bank collapsed, you would be covered up to $250,000. Just make sure you won’t need the invested money during the agreed term – there are big penalties for early withdrawal.
6. What is retirement planning?
This is all about investing for your retirement – based on a form of investment account with certain tax benefits. The basic types are the 401(k) and 403(b) plans that are sponsored by an employer, or an Individual Retirement Plan (IRA) if you don’t have an employer-sponsored scheme.
Essentially, all these plans are a platform for buying stocks, bonds, and funds in a couple of tax-efficient ways. Firstly, the traditional IRA-type plan lets you invest pre-tax dollars. The second approach lets you withdraw funds without paying tax – as with a Roth IRA.
There are no specific risks with retirement plans.
7. What are options?
This is a more complex way of buying stock. Here, you’re buying the ability to trade an asset – at a certain price and time. There are two types of this investment. When buying assets, they’re ‘call options’, and when you’re selling assets, they’re ‘put options’.
With options, you ‘lock in’ the price of a stock and hope that it will go up in value. There is an element of risk: if the stock decreases from the initial price, you’ll lose the money of the contract. This is probably an investment approach best left to experienced investors who can handle higher risk.
8. What is an annuity?
An annuity is a kind of insurance policy, for which you get payments in return.
These payments are usually associated with retirement, but the initial purchase is made years before. There are lots of different kinds of annuities – they might last until your death, or for a predetermined period. Some require periodic premium payments while others require just one up-front amount. Annuities are sometimes linked to the stock market, but equally might just be an insurance policy, and they come in both fixed and variable types.
Annuities provide a secure income stream for retirement, with low risk, but also modest growth potential. They tend to be a supplementary element to a larger retirement savings plan.
9. What is a derivative?
Like an annuity, a derivative is a contract between two parties, but here the contract is to sell a particular asset at a specific price in the future. When you invest in a derivative, you are calculating that it won’t decrease in value. These are more advanced investments, which tend to be favored by institutional investors.
Derivatives will make you money if you invest on the right side of a price fluctuation. So, for example, if you commit to buying copper in nine months at $1,000, but when the time comes the price is $2,000, you’ve doubled your investment.
10. What is a commodity?
This is all about investing in material goods. In the futures markets, professional producers and commercial buyers take calculated risks and invest in physical products, hedging their bets on the basis that prices will rise.
You should approach this kind of investing with caution because the price of commodities can change dramatically and quickly.
How to choose the best type of investment for you
There are so many types of investment to consider – each with its own balance of risk and reward. Some are just right for beginners while others are best left to the seasoned investor with an appetite for risk and deep pockets.
You need to match your chosen investments to your financial goals, the amount of money you can afford to invest – or potentially lose – and your future security.
If you’re at the beginning of your journey into investing, it’s best to talk through the options to speak to a professional financial advisor, who will be able to steer you in the right direction, based on your personal circumstances.
Senior Content Writer
Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.