Investment Types

Different types of investments have different benefits and risks.

Diversification is an important strategy for protecting your investments. A diversified portfolio is one with multiple types of investments in many areas. If one investment underperforms, growth from others can make up for it. This approach also helps protect you if the value of one of your investments drops significantly.

To understand why diversification is important, think of a bake sale. If you only sold brownies, and no one wanted to eat brownies on the day of the sale, you wouldn’t make any money. But if you also sold cupcakes, cookies, and bread, the money you earned from those could make up for the loss of brownie sales.

Ideally, you have stocks, bonds, and at least one fund in your portfolio, and investments within those categories from different industries or areas of the market. This way, all of your investments don’t fall if one area performs poorly.

It’s also important to think about the difference between investing in financial assets like stocks, CDs and share certificate, and bonds, vs other assets like real estate or gold. These tangible assets are things you can touch or hold in your hand, which means you can be sure you can sell them, but they can also be lost or damaged. Financial assets, on the other hand, can be nerve wracking because you may not be able to see or touch them, but you don’t have to worry about them getting lost.

Corporate stocks are pieces of ownership within a company. Most often, you make money with stocks by selling them for a higher price than you paid. This is where the phrase “buy low, sell high” comes from. Ideally, you purchase stock from a company when the price is still relatively cheap. Then as the company grows, the value of your stock goes up. From there, you can sell the stock to other investors for more than you originally paid for a net profit. Of course, stocks can also go down in value, requiring you hold on to them or sell for less than you paid. Another way to earn money from stocks is by dividends. If a stock pays dividends, investors receive regular payments when and if the company earns profits. Not all stocks pay dividends and, of course, it’s not guaranteed that the company will earn enough to pay them out.

Bonds are like loans. Most often, these are loans to businesses, called corporate bonds, or government entities, typically called municipal bonds or treasury bonds. While the entity uses the money lent to them, they make regular interest payments to the investor. A bond matures when the contracted agreement for the loan ends and the investor is repaid the loaned money. Bonds tend to offer lower returns than stocks, but they’re also lower risk. There’s always the chance the borrowing entity defaults and stops making payments, but that’s unlikely, especially with treasury bonds or other bonds from the government. Government bonds in general are more stable and liquid than corporate bonds, but corporate bonds often offer higher yields.

Mutual Funds

A mutual fund is a pool of investor money spread between companies and investment types. Mutual funds are managed by a professional who oversees the growth and strategy of the fund. Mutual funds often have a minimum investment (often in the thousands of dollars) and carry operating expenses and fees. Because a mutual fund is inherently diversified, they’re often less risky and more protected from changes in the market. This also means that you may not see the gains you would if you happened to invest in a stock that performed well.

Exchange-Traded Funds (ETFs)

Like mutual funds, ETFs are professionally managed groups of investments (often called “baskets”). But ETFs don’t generally have minimums. You can buy into the ETF for as little as one share. You also have more flexibility and control over the price of the trade because ETFs are traded multiple times throughout the day and mutual funds are only traded once per day.

While you may not always think of a house or other form of real estate as an investment, it can be a valuable tool for building wealth. If you buy a house, it's likely the value of that house will grow over time, especially if the house is in a popular area. When you’re ready to sell, you’ll likely make more than you bought it for. Of course, when you’re talking about home and real estate prices, you’re talking about bigger numbers. After all, the average home price in America is around $350,000. Because of this, real estate isn’t the kind of investment that most people buy and sell often. It also isn’t without risk. The home or land could be damaged in any number of ways, lowering the value or requiring expensive repairs. There’s also no guarantee that real estate will grow in value over time, even if it is likely.

There are many different ways to invest. It’s important to understand the differences between potential investments and how they work so that you can invest safely and effectively.