If you have recently come into money or are a young adult earning significant income for the first time, you may be asking yourself, “What are the most common types of investment?”
It’s a basic question that has many answers. To begin, the single most common type of investment is a savings account. Almost everyone you know has a savings account (as long as they are not “unbanked,” meaning they are part of the 2.5 billion people in the world without access to traditional financial services).
Two important categories to know when it comes to different types of investment include types of investment instruments and types of investment terminology. Everything in the investment world has its own terminology. The instruments themselves have unique terms, and there are further terms to be familiar with to describe the finer details of how they work.
Types of Investment Instruments
Bonds, stocks, mutual funds, and ETFs are all investment vehicles that everyone should make themselves familiar with. Most people will have heard these terms before but may not know what they mean.
Here are some of the most common types of investment instruments:
A bond is an instrument of debt. In essence, a bond is a loan that you give to an institution or government. In return, you get a pre-determined interest rate paid on a regular basis for a specific period of time.
The bond yields you interest while it’s active and pays out its total face value at the time of its expiration.
When buying a bond at the time of its issuance, the face value you receive at the time of the bond’s maturation will be the same amount you paid for it initially. The return you receive from a bond under such circumstances is the interest payment (also known as the coupon).
If you buy or sell a bond in-between the time of its maturity and issuance, you could experience gains or losses on the face value of the bond itself.
A stock is an investment that lets you own a portion of a publicly traded company. Stocks are commonly referred to as “shares,” implying that the value of the company is shared among its “shareholders,” or people who own stock in the company.
Stocks are one of the most popular types of investment instruments. Shares of large, successful companies are often seen as an integral part of any investment portfolio.
Some companies offer their employees stock in the company as part of a retirement contribution, bonus package, or severance package. If the company performs well over the long-term, this can wind up being a very generous form of compensation.
For the average person, stocks are a very long-term type of investment (as are bonds). Unless you’re an experienced day trader, it’s wisest to hold stocks in well-established companies for the long run. 401(k) and Individual Retirement Accounts (IRA) accounts are a few of the most common methods used for doing just that.
A mutual fund is a sort of diversified investment vehicle that contains several components of different investment sectors.
Mutual funds offer investors the opportunity to invest their money in a professionally-managed portfolio of assets. The portfolio most often consists of a mix of market-related indexes, bonds, stocks, and other types of investment instruments.
The valuation of a mutual fund is determined at the end of the trading day. Buy and sell orders are also executed following market closures as well.
Mutual funds are often passive investments that follow bond or stock market indexes like the NASDAQ, the Barclay’s Aggregate bond index, and others. Some mutual funds, however, are managed actively and have a manager who handpicks bonds, stock, and other investments that the fund holds.
Funds that are actively managed tend to be costlier. A fund’s expenses reduce the total returns on investment that mutual fund investors will receive.
Mutual funds can be one of the more convenient types of investments because they offer investors the opportunity to acquire diversified exposure to many different investment holdings within the fund. For example, a mutual fund specializing in foreign stocks could hold 100 stocks listed on exchanges in other countries.
A relatively small investment can allow an individual investor to hold a portion of all the assets managed by the fund.
Exchange-Traded Funds (ETF)
ETFs trade like other stocks on an exchange. The difference is that an ETF does not represent shares of a single company. In fact, an ETF doesn’t even have to be tied to stocks at all – it could be tied to commodities, like gold, for example.
An ETF is also sometimes referred to as a basket or portfolio of securities. When you buy an ETF, what you are actually buying represents shares of the overall fund and not actual shares of any single underlying financial instrument.
A gold ETF might involve gold mining stocks, stocks of companies that deal in the sale and distribution of gold, and options contracts tied to the price of gold, for example.
Over the last ten years, an entirely new asset class has been born – digital assets.
The technical name for this type of investment is cryptocurrency. Cryptocurrencies like Bitcoin have become quite popular and are now mainstream investments. Financial news sources like CNBC, Forbes, and Business Insider frequently cover events in cryptocurrency markets.
While many criticisms of cryptocurrencies exist, they are becoming more and more accepted as a legitimate part of an investment portfolio.
Digital assets have provided monumental returns for investors. Some early adopters of the new technology have seen returns ranging from 1,000% to 10,000% and more in a matter of a few years. By comparison, a stock market portfolio that gains 7% a year is widely considered to be a winning strategy.
Mineable cryptocurrencies have value because of their fixed supply and the blockchain technology that they were founded upon. In essence, something with finite supply (like gold) tends to rise in price, assuming demand rises or remains constant. New technology, like the blockchain, often produces good investment results as well, assuming it continues to grow and evolve.
While digital assets are somewhat shrouded in controversy, most of them are considered to be risky and highly speculative. Their prices can be very volatile. That being said, their use as part of a diversified investment portfolio has been becoming more and more common.
Types of Investment Terminology
Some types of investment terminology may be foreign to new investors. Without knowing the vocabulary of any subject, obviously, it’s difficult to make sense of most relevant information.
Here are a few common investment terms:
A capital asset is a long-term asset that doesn’t get sold or bought during your normal, daily business. Common examples are a building, a piece of land, your car, your home, or your retirement portfolio consisting of stocks, bonds, and other types of investment.
Capital Gain or Capital Loss
Capital gains or capital losses simply refer to the amount of profit or loss netted from the sale of an asset.
There are both long-term and short-term capital gains and losses, both of which come with their own unique set of appropriate tax laws. In general, assets held for longer periods are taxed at lower rates than those that are bought and sold quickly.
The term “yield” refers to the income that an investment returns. If the yield on a bond is 1%, for example, it means that owners of the bond will receive 1% of their total investment as a result of owning that bond.
An index is a portfolio of securities that are intended to represent a specific industry or market. Indexes are used to measure overall investment performance. An example would be the S&P 500 index, which tracks the performance of the S&P 500.
While indexes are not financial instruments that can be owned, mutual funds and ETFs are based on certain indexes.
Types of Investment Summarized
All in all, different types of investment instruments and investment terminology are important to know. They’re not all that complicated, but being aware of the basics is necessary to make good decisions.
Listening to mainstream financial news sources like CNBC is a good way to become familiar with related topics.