Perhaps you’ve heard that investing can be a great way to grow your money over time. But when you’re just getting started, understanding all the lingo and investment options can feel overwhelming.
We’ll break down some of the words you’re likely to hear and look at some common types of investments, so you can feel more confident getting started.
What is an investment?
An investment is any asset that you purchase with the intention of generating a profit, typically in the form of income, an increase in value or both. Anything with the potential to increase in value over time, whether in the short or long term, can be considered an investment.
What are some different types of investments?
You may hear people talking about investing in things like wine, art or other assets. But typically, when people are looking to grow their money for future goals, they start by looking at more traditional investments like stocks and bonds.
Traditional investments include the following:
A stock is a financial instrument that represents partial ownership of a company. When you purchase shares of a company’s stock, you are becoming a partial owner of the company, which entitles you to enjoy the company’s success and profits. However, if the company does not perform as well, it’s possible the stock will lose value.
Investors can make money with stocks either by selling the stock for more than they paid for it (if the price goes up) or by receiving periodic distributions from the company in the form of dividends.
Investing in stocks can be risky, as there is no guarantee that a business will be successful or that the share price will go up.
A bond is essentially a loan that you (the bondholder) make to a bond issuer. Bonds can be issued by businesses as well as different government entities (such as the U.S. Treasury, federal agencies and municipalities).
Bonds work just like any other loan: When you hold a bond, you will receive regular interest payments from the bond’s issuer, according to the terms of the bond. Once the bond matures, you will get your initial investment back. For this reason, bonds are often referred to as fixed-income investments.
If you decide that you do not wish to hold a bond until maturity, you can also sell it on the open bond market. However, the value of bonds on the secondary market can fluctuate significantly depending on several factors.
While bonds are considered a less risky investment compared to stocks, they still carry some risk: Primarily, that the bond issuer might default on its obligations. Risk varies with distinct types of bonds, so it’s important to understand how each type of bond works and what role it may play in your portfolio.
Selecting individual stocks or bonds to invest in can be time consuming and difficult to manage for someone who may not have the skills and expertise necessary to choose individual investments. This is where funds can be helpful.
A fund holds multiple stocks, bonds or other investments. It’s a way to make one investment and be instantly diversified.
Funds come in several different forms, including:
- Mutual funds: Mutual funds tend to be actively managed, meaning their holdings are periodically adjusted depending on the fund’s goals and human analysis of the market. Mutual funds can be built in many different ways and tend to carry higher fees compared to other types of funds.
- Index Funds: Index funds track an underlying index, such as the S&P 500. These funds are passively managed and therefore typically carry lower fees. Since you can’t actually invest in the Dow or S&P 500 (indexes you probably hear quoted frequently), index funds are as close to “investing in the market” as most people can get.
- Exchange-traded funds (ETFs): ETFs are like index funds in that they tend to track a particular index and generally carry low fees. They are different because they are traded on the exchange. With other funds, the price usually only changes once a day and you’re only able to buy and sell on a daily basis. Shares of ETFs, however, can be bought and sold as prices change throughout the trading day.
Investing in funds is generally considered to be less risky (compared to selecting individual stocks or bonds) due to their diversification. It is important to understand the fees that you are charged for investing in funds, as these fees can eat away at your total returns over time.
Certificates of Deposit (CDs)
Certificates of deposit (CDs), offered by banks, are designed to provide an investor with a low-risk way of generating fixed income.
CDs can be thought of as something like a contract in which you agree to keep your money deposited with a bank for a certain length of time, and they pay you a higher interest rate than you may find with a traditional savings account. Common CD terms are three months, six months, one year, three years, or five years.
CDs are FDIC insured, essentially eliminating the risk that you would ever lose your principal (up to a certain amount). However, returns on a CD may or may not keep up with the pace of inflation, which might eat away at your buying power over time. Additionally, if for whatever reason you need to access your money before the CD matures, you will typically pay a fee in the form of forfeited interest.
Most new investors stick to stocks and bonds (usually purchased through funds). But there are additional types of investments that investors tend to include in portfolios as their investment knowledge grows over time, including these:
- Real estate
- Private equity
- Private debt
- Hedge Funds
Alternative investments can offer investors numerous benefits, including the potential for dramatic gains. However, it is important to understand that this potential comes with significant risk. Investors interested in including alternative investments in their portfolios should carefully consider the role that these investments will play in the context of their greater portfolio and be mindful of the amount of the risk they’re taking on. Another thing to keep in mind — unlike traditional investments, alternative investments may be less liquid and harder to convert into cash. Alternative investments are not suitable for all investors.
What is not an investment?
It’s important to recognize that some financial products are not investments. A checking account that does not accrue interest (or that accrues a negligible amount of interest) is not an investment. A savings account, which is meant to help you save, not grow, money, is also not typically considered an investment.
How to buy and sell different types of investments
To purchase traditional investments, you must open an investment account. Often, this will take the form of a personal brokerage account. Other types of accounts that allow you to purchase investments include 401(k)s, IRAs, 529 college savings plan, and custodial accounts.
For alternative investments, you may need to open an account specifically dedicated to holding such investments or purchase the assets on the open market. Access to alternatives may also be restricted to investors who meet specific suitability and best interest requirements, including minimum assets and net-worth standards. Financial advisors and wealth managers can also often help you incorporate alternative investments into your portfolio.
Managing your investments
Different types of investments may help you reach different goals. In addition, there are other financial options that can work with your investments to help you reach your financial goals while also managing risk.
That’s where a financial advisor can help. An advisor can get to know you and your goals. Your financial advisor can help you get on track for future goals while being mindful of what’s important to you today. Your plan will help you manage potential risks so that you can worry less and spend more time doing what’s important to you today and in the future.
All investments carry some level of risk including the potential loss of all money invested. No investment strategy can guarantee a profit or protect against loss.