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Investing is one of the main vehicles people use to grow their wealth. Investing allows your money to make money of its own. To quote “Rich Dad, Poor Dad”– it allows money to work for you. While there are many different types of investments out there, below are six of the more common types. Each has its own pros, cons, and risks. Let the below list of 6 types of investments you should know help guide you to what works best for you.
Purchasing individual stocks is like purchasing a share, or a stake, in a specific company. Shares are worth a certain price based on what people perceive the company to be worth. That value fluctuates over time allowing for the investor to make or lose money on those shares.
When you purchase stocks, you will typically also receive dividends. Dividends are regular payouts the company will make per share based on the company’s standards and how they have performed.
Stocks are generally perceived as very risky, as individual company’s stock can be very volatile. As an investor, you have the opportunity to both make and lose large percentages of money. It is generally not recommended for the beginner, or passive, investor to invest in individual stocks due to the effort and unpredictable nature that comes with it.
Bonds are a type of loan that you are making to government or a specific company. As with typical loans, bonds come with an initial loan amount, set interest that will be paid out during the length of the loan, and the term, or how long the bond is good for. At the end of the term, the borrower pays back the originally principal on the loan. Now you, the lender, have made money through interest off of that loan.
Similar to stocks, you can trade bonds on an open market. However, bonds are considered to be a safer investment as the bond is more or less a contractual investment- however, it is still possible for you to lose on bonds (through a government or company failing), but it is less likely. While bonds are a safer investment, they do typically have a lower return on investment.
For example, let’s say you purchase a bond for $10,000 at an interest rate of 4% paid annually for 10 years. You will get $400 every year through the term of the bond and at the end of 10 years you will have $14,000.
3. Mutual Funds
A mutual fund is a set of individual stocks/bonds that are all pooled together by a professional manager or company. As an individual investor, you can purchase a portion of this diversified investment by hiring a professional manager/company to invest your money for a fee. Mutual funds allow you to diversify your investment while having a professional company manage your investment.
There are pros and cons to hiring a mutual company. One benefit is that you do have more diversity of your investment. However, because you are paying a fee (typically 1-2% of total investment) to have someone manage your investment, your investment must have a higher return on investment to make up for the fee.
4. Index Funds
An index fund is similar to a mutual fund, in that you are able to diversify your investment but you don’t have to pay a manager to do so. For example, through Vanguard, you can purchase VTSAX which is representative of the total US stock market for a very low fee (~0.04%). By purchasing a low-cost index fund, you are essentially investing in the general US stock market which has historically increased in value over time.
With index fund investing, you no longer need a mutual fund manager to beat the market to cover their fee, as you are already meeting the market return at a very low cost.
5. Exchange Traded Funds
Exchange traded funds, or ETFs, are similar to index funds. While index funds are a culmination of a general section of the stock market and fluctuate based on the fluctuation of the individual stocks that make up the fund, ETFs are actually funds that can be traded- just like regular stocks.
6. Real Estate Investing
Real estate investments can be both passive and active investments. They are good for investors that want more ownership and direct influence over their investment. Through real estate investing, you can set up long term returns by purchasing long term rentals, as well as make quick returns through active investing like flipping houses. Many an investor have been able to grow their wealth exponentially through real estate investing, but because real estate investing is a lot more hands on, we recommend you take the time to learn about what is involved before diving in.
Learn more about real estate investing here.