In this article, I will be talking about the different types of investments you can make, and share some knowledge to get you started. Basically, investing is saving money with the intent of making more money.
Let’s get into covering some of the major types of investments, obviously not everything because that would make this article a novel in length.
There are four main types of investments available.
The first is lending aka debt instruments. This is where you lend money in return for being repaid within a certain period of time and getting a certain rate of return. So you are acting as a lender, and someone else owes you money. For example, this could be a bond.
The next type of investment is ownership. This is where you actually own a piece of something; it could be stock in a company, it could be real estate or it could be a pile of gold or something.
Another investment category is cash and cash equivalents. These are things that are easy to convert to cash, like a savings account or a checking account or cash, well because it’s cash. Unless you have retired already, a self managed superannuation fund isn’t that easy to convert to cash.
The next investment category is insurance and annuities. These are a little bit of a mixture, however their investment options offered by an insurance company that’s really the key part. A great example would be a whole life insurance policy. So this kind of policy has a cash value that grows based on dividends that the insurance company pays you. These investments can get complicated really fast.
There are also hybrids that mix one or more of these categories, including lending instruments, ownership instruments and cash and cash equivalents. An example of this would be mutual funds.
Now, just in case you haven’t heard of the concept of diversification, this means simply a mix of investments. Why do you want this? Well it’s reducing your risk. You know that old saying, “don’t put all your eggs in one basket”, well this is it. If you put all of your money in stock and then the share markets crash, then you go bankrupt, and you’ve lost everything.
You wouldn’t want to do that, so you want to spread it around. Because more than likely, not every company is going to go bankrupt or at least not at the same time. You may also want to consider a mix of stocks, bonds and also cash and cash equivalents, because you want to maintain your liquidity.
Now, liquidity is when you spread things out, and you have a nice mix. It reduces your risk and exposure to risk in any one given area, while also still being able to maximize your return. Simply because we all want our money to grow, that’s why we’re investing.
Now let’s take a deeper look into these different types of investments.
Lending and debt instruments
Starting with lending and debt instruments. So one of the benefits of a lending instrument is that you get a guaranteed rate of return, however the downside is that that rate of return tends to be lower then if you were to take advantage of ownership instruments like stocks.
One example of this would be corporate bonds. These are bonds that are issued by a company when the company wants to raise money. They have a couple of options; they can either sell stock in the company, which is selling ownership in the company, they can take out loans or they can issue bonds to investors. Bonds are basically like IOU’s, where the company is promising to pay the investors back, however the investor does not get any ownership in the company.
Another example of bonds are municipal bonds. These are offered by state and local governments, and there’s also Treasury bills, also known as T bills, which are considered to be the absolute most safe type of investment in existence, because they’re offered by the US government.
Then lastly, we have foreign bonds which are also known as sovereign bonds which are issued by foreign governments and actually foreign bonds in emerging countries have been like super hot commodities of late, however they can be very risky.
Ok, so now let’s talk about ownership. This is one of the different types of investments, where you actually own a piece of something. There are pros and cons because as the value of what you own goes up, you get to enjoy 100% of that, however if it falls, then so does your investment and there is no guarantee that it’s going to work out.
Remember that owners always get paid last in bankruptcy, however the upside of ownership is unlimited. Whereas, with a debt or lending investment, well your rate of return is fixed. Ownership is definitely where the money is at. An example of this would be real estate, say your own house or perhaps you own a piece of an apartment complex and the biggest one that we all know stock.
This is where you own a piece of a company, sometimes a teeny weeny piece because there are millions of shares of stock and you just own a little bit of it, maybe just a few of them. There are tons of different types of stocks, across many stock exchanges. All different kinds of features, some pay dividends and some don’t.
Cash and cash equivalents
Next on our list of different types of investments, we have cash and cash equivalents. These are your most liquid investments, and they’re easy to spend, easy to convert to cash and they include things like, well, cash. Your bank accounts are cash, and because it’s easy to pull that money out, however it also includes things like money market accounts, and CDs also known as certificates of deposit, which carry a higher interest rate than just a plain old savings account without much additional risk.
The real problem with cash and cash equivalents, is that their rate of return is typically not high enough to outpace inflation. So, if you keep most of your investments in cash and cash equivalents they will lose value over time.
Insurance and annuities
We mentioned insurance and annuities at the beginning of this video however there’s a very wide selection under this category, so it is very complicated, and therefore difficult to really cover here.
An annuity is often also known as a fixed term pension or lifetime pension, and as the name implies, these will provide you with a guaranteed monthly income for either the rest of your life, or for a specific number of years.
You can use your super or savings to buy an annuity from a super fund or life insurance company. Whilst they are not as flexible as account based pensions, annuities do ensure you have peace of mind with your future income.
So moving right along to hybrid investments. Basically, these are funds where a large group of investors pool their money together to buy a mix of the different types of investments. These typically can include stocks, real estate, cash and cash equivalents, and bonds. Yes, basically everything.
The first example of a mutual fund, is a mix of investments that are managed by a portfolio manager. So you are giving your money to somebody to invest on your behalf, and you’re paying them a fee to do it. I believe it’s really important to note here that you will have decided in advance which mutual fund you want to invest in, because they’ve already outlined the specific things that each individual mutual fund invests in.
There are some that are actively managed, which means they’re trying to find new stocks and different investments to beat the overall market, and other kinds of mutual funds are basically just trying to keep pace and track the market, because they don’t believe that actively managed works any better.
An index fund is one particular type of fund that mirrors a market index. A market index is a sampling of a group of companies that is used to measure overall market performance. Think of index funds as your grocery staples. Every week, you might buy eggs, bread and milk. So you should know what these eggs, milk and bread should cost. So if the price of these went up suddenly, that means that you know well from a groceries perspective.
Basically, when you think of your standard groceries, those are your companies and from a stocks perspective, if the price is going up that means the market is doing well.
However, if the price is going down on that bucket of companies, that means most likely the overall market is going down. The general idea is that for a particular index, you can track that index and expect to get a certain rate of return over the long term.
Another hybrid on our list is an ETF, which stands for exchange-traded fund. These are like indexes above, and are bought and sold on the stock market, exactly like a stock.
These ETF’s are super easy to buy and sell, and they don’t take much to invest in. Just whatever the share and a commission for the trade is, so it’s even easier than buying a mutual fund which can have higher fees and a higher cost of entry.
Another type of hybrid investment is a hedge fund. The only reason that I’m including hedge funds is because they are in the headlines and you’ve heard of them. However, honestly you don’t need to know about them unless you have plenty of money to invest.
Hedge funds are private investment pools where usually very rich people or corporations come together and they invest in a variety of areas that they keep very private, so we have no idea how well they do or what they invest in.
I hope the above summaries of the different types of investments have been able to add some value to you.
Please keep in mind that this article really is just a simple, high level overview of just the major different types of investments. There are a plethora of ways to invest, however that could easily make this article a whole series of articles, or even a book.