… and risks.
Not gonna lie: the amount of investment options out there today is totally overwhelming. Figuring out where you should invest, how much, if the timing is right, who can help you, all of this can be a daunting task. In this article, we’re going to categorize all the investment possibilities for you so you can choose the ones that align best with your financial plan.
There are five main types of investments, and each comes with its own set of unique characteristics. Let’s explore each type and the benefits and risks associated with each:
Cash and cash equivalents – This is a broad term for anything that is actual hard cash in your wallet, as well as investments that function the same as cash. Essentially anything that can be easily drawn on to get money for you quickly. Bank accounts are a good example of a cash equivalent.
- Examples: checking and savings accounts, money market accounts, CDs (certificates of deposit)
- Benefits: Can easily get your money when needed. No risk of losing your money.
- Risks: Typically extremely low returns on your money. Difficult to grow your money and keep up with inflation.
Bonds – A bond is an investment that works like an IOU. You give a company or the government some money, they pay you interest while they have the money, and then you get your money back one day in the future. Bonds are not a super common investment for everyday investors like you and me.
- Examples: Savings bonds, international bonds, municipal bonds (from state and local governments), corporate bonds (issued by companies like Apple)
- Benefits: Interest is paid on a regular schedule. Returns are higher than cash and equivalents.
- Risks: Rising interest rates lower the value of a bond. Your money is locked up until the bond matures (could be 30+ years). The underlying investment amount you invested will never increase. The bond issuer may not be able to repay you.
Stocks – Stocks and ETFs (exchange-traded funds) are a very common investment for everyday investors. A stock investment is one that represents a small portion of ownership in a certain company. For example, if you own 10 shares of Tesla stock, you own something like 0.0000000003% of Tesla the company. Crazy, right? ETFs operate by lumping your money in with many other investors to buy lots of different stocks. As an example, if you bought the ETF with the ticker symbol of XLF, you would own shares in a fund that owns lots of bank and insurance company stocks.
- Examples: Owning stock shares of companies like Apple or Tesla, owning shares in ETFs like SPY or QQQ
- Benefits: When stock market prices go up, you can make money. Many stocks pay dividends. Most stocks can be easily and quickly sold when you want or need your money back. Stocks generally increase in value when inflation increases. Returns are usually higher than bonds and cash.
- Risks: You may not make your original investment back if the company or companies are not doing well or if the stock market in general is falling (even if the company you own seems to be doing well otherwise). You may need to sell your stocks or ETFs at a time when their value is down.
Real estate – We’re not talking about the home you live in, but rather real estate that you buy as an income-generating investment. A common and accessible way to invest in real estate nowadays is in real estate crowdfunds.
- Examples: A rental house, apartment buildings, shopping centers, office or industrial buildings
- Benefits: Can make dependable cash returns on a regular schedule from rents. Returns often exceed the investment types above. Real estate values typically keep pace with inflation.
- Risks: High up-front costs to buy investment real estate. Rising interest rates can make real estate loans more expensive. Your money is locked up until you sell the property. Tenants may not pay rent on time. Usually very high up-front costs.
Alternative investments – Now the category that doesn’t fit anything above. Alternative investments are a critical component of your financial plan because they are not “correlated” with stocks, bonds, or real estate (i.e. provide excellent diversification). This means that if the stock market is going down, or if real estate prices are plummeting, returns on alternative investments may not be doing the same. Or conversely, alternative investment values may be going down while stocks, bonds, and real estate are going up.
- Examples: Precious metals (stocks in gold, silver, and mining companies), crowdfund investments (everything from personal and commercial loans to artwork and collectibles like baseball cards), venture capital and hedge funds, investments in commodities (like corn, wheat, and oil)
- Benefits: Are not correlated to stocks, bonds, or real estate. Can be a vital part of diversifying your investment portfolio. Frequently offer high returns, stable income, and the potential to grow your money over time. Usually not sensitive to changes in interest rates.
- Risks: Frequently difficult to sell or redeem your investment when you need it. Can more easily lose money if the investment does not perform well.
For lots more on how to crush the personal finance game and find early retirement, make Firreo your financial advisor. We’ll help you out of your job and on your way to financial freedom!