Types of Investments
As an investor, you have a variety of vehicles to invest in. Each type of investment comes with its own risk-return profile. What that means is generally higher returns on a type of investment is associated with a higher level of risk. Here are some of the different types of investments that may be available to you:
Bank Products are the safest types of investments
Checking and savings accounts are basic products most banks and credit unions offer. These accounts help provide liquidity and check-writing capability. Some banks offer money market accounts that provide better interest rates compared to savings accounts. These are usually FDIC insured.
Stocks – usually a risky type of investment
When you buy shares of a company, you own a piece of the company. The share may not be significant enough for you to influence the decisions the company makes, but you may still vote at shareholders’ meetings. Stocks allow investors to share in the financial success of the company through price appreciation and/or dividends. However, you also partake in the company’s financial falls that could lead to a dividend cut or price depreciation. The risks associated with stocks are not limited to factors within the company’s control. There are geopolitical risks, economic risks, currency risks, etc. Within stocks, there are a wide variety of selections on what kind of companies you want to own. I will go over these choices in detail in another article.
Simplistically, a bond is a loan that an investor makes to the government or an organization over a specified term with a promise that the investor will receive interest in addition to the principal by the maturity date of the loan. Government bonds, municipal bonds, corporate bonds, and mortgage-backed securities are some of the different types of bonds available for investment.
Mutual funds, closed-end funds, and exchange traded funds (ETFs) pool money from investors to invest in other investment vehicles as defined in the fund prospectus. Some important considerations for investing in funds are management, strategy, management fees, investment minimums, restrictions on contributions and withdrawals from the funds, and the discount to the net asset value in case of a closed-end fund.
Hedge funds and private equity fall under this category. These investments require investors to be accredited, which means they have to meet certain annual income or net worth requirements. There may also be opportunities to invest in startup firms that require capital for R&D and growth. Alternative investments have a huge potential upside but also carry huge risks. Investors need to be cognizant of, and have the appetite for, these risks before considering an investment.
Derivatives are contracts that derive their value from an underlying entity, such as an individual index, a stock, a commodity, or interest rates or a basket of that entity. Options, forwards, futures, and swaps fall under the category of derivatives. These complex products are not for novice investors, but it may be worthwhile to learn about derivatives, trading strategies, and the risks involved.
Term life insurance is a temporary policy that pays in the event of a disability or death. This kind of policy is useful in your early years of employment and it is less expensive compared to a whole life. As one gets older, one may want to consider a whole life. Some term policies can be converted to whole life.
If you have children, college savings plans are a good way to put aside money in a separate account, grow it and invest in your child’s education. Moreover, some states offer tax breaks on a certain maximum contributed annually to college savings plans. That is an added benefit of college savings plan. Both parents are able to contribute to two separate college savings plans.
There are several options available to save for retirement. Your employer may have a pension plan, which is a defined-benefit plan. In addition, you may be able to save for retirement through a 401k plan, an individual IRA or a Roth IRA. More about saving for retirement can be found here.