6 Major Types of Investments
There are many types of investments available: stocks, bonds, and mutual funds. Find out which one might be right for you.
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You have many options when it comes to where you can invest your money as an investor. It is important to carefully weigh the pros and cons of each type of investment.
Generally, investments can be divided into three main categories: cash equivalents, stocks, and bonds. Each bucket can contain many types of investments.
These are six types you might want to consider as long-term investments. Here’s what you need to know about them. Not to be confused with cash equivalents, such as money markets, certificates of deposit, or savings accounts. These types of investments are more about protecting your money than growing it.
Six types of investments
Stocks
Bonds
Mutual funds
Index funds
ETFs are exchange-traded funds
There are many options
Stocks
Stock is an investment in a company. You buy a stock to purchase a small percentage of the company’s earnings or assets. To raise capital, companies sell stock shares in their businesses. Investors can then purchase and sell these shares. Stocks can sometimes yield high returns, but they also carry more risk than other investments. Companies could lose value or go out of business. Check out our complete explanation of stocks.
How stock investors make money: Stock investors are successful when their stock value increases and they can sell the stock for a profit. Dividends are regular payments of earnings from a company to investors.
Bonds
A bond is a loan that you make to a government or company. You are granting the bond issuer permission to borrow money from you and then pay you back with interest.
While bonds are considered less risky than stocks they can also offer lower returns. As with all loans, the primary risk is that the issuer might default. U.S. government bonds can be backed by the “full credit and faith” of the United States. This effectively eliminates the risk. Corporate bonds are the next less risky option. The interest rate is generally lower for bonds that are less risky. Our introduction to bonds provides more information.
How investors make money: Bonds can be considered a fixed-income investment because investors expect regular income payments. Investors receive interest in regular installments, usually once or twice per year. The principal amount is then paid at maturity.
Mutual funds
You’re not the only one who doesn’t like the idea of choosing individual stocks and bonds. A mutual fund is an investment that’s made for people like yourself.
Investors can purchase multiple investments through mutual funds. These funds combine money from multiple investors and then hire a professional manager who will invest the money in stocks, bonds, or other assets.
Mutual funds have a defined strategy. A fund may invest in certain types of stocks or bonds like government bonds or international stocks. Some mutual funds invest in stocks and bonds. The risk of a mutual fund will depend on its investments. Learn more about mutual funds.
How mutual funds make money: Mutual funds distribute a portion of the money it earns to investors, such as stock dividends and bond interest. The fund’s value increases when investments are made in it. This means that you can sell it for profit. To invest in mutual funds, you will need to pay an annual fee (also called an expense ratio).
Index funds
An index fund is a type of mutual fund that tracks an index passively and does not pay a manager to make investments. An S&P 500 index fund, for example, will seek to replicate the performance of the S&P 500 Index Fund by holding stock from companies in that index.
Index funds are more cost-effective than traditional managers because they do not have an active manager. An index fund’s risk will depend on how it invests. Find out more about index funds.
How index funds make money: Investors may receive dividends or interest. The funds can also rise in value if the benchmark indexes that they track the increase in value. Investors can then sell their shares in the fund to make a profit. Although index funds can also be subject to expense ratios, they tend not to charge as much as mutual fund fees.
Exchange-traded funds
ETFs can be described as index funds. They track a benchmark index and seek to replicate that index’s performance. ETFs are similar to mutual funds but they are less expensive than mutual funds as they don’t have to be actively managed.
ETFs and index funds have one major difference: ETFs trade on the exchange just like stocks. This means that you can purchase and sell ETFs all day long and the price of an ETF will fluctuate throughout the day. ETFs and mutual funds are priced at the end of each trading day. This price is the same regardless of when you sell or buy. The bottom line is that this difference doesn’t really matter to most investors. However, if you desire more control over the fund’s price, an ETF might be a better choice. More information about ETFs is available here.
How investors make money: Just like with mutual funds and index funds, your goal as an investor is for the fund to increase in value so that you can sell it at a profit. ETFs can also pay dividends or interest to investors.
There are many options
An option is a contract that allows you to purchase or sell stock at a fixed price and by a specific date. Options allow flexibility as you are not obligated to purchase or sell the stock. You have the option to do so, as the name suggests. Options contracts typically cover 100 shares of stock.
You are buying an option and not the stock. The options contract allows you to either sell or buy the stock at the agreed price within the agreed time or sell it to another investor. Learn more about options.
How investors make money: Although options can be complex, at the most basic level you are locking in a stock’s price that you expect to rise in value. If you have a crystal ball, the stock will be less expensive than the current rate. You can cancel the purchase if it’s not right. The contract will only be refunded the price of the stock.
How to buy different types of investments
A brokerage account is required regardless of what investment you make. A brokerage account is different from a bank account. It allows you to purchase and sell investments.
In just 15 minutes you can open a brokerage account and once it’s funded, you can start investing. You will find tools on the broker’s website to help you locate the right investments, as well as educational resources. For more information on opening a brokerage account, please read our complete guide.
