If you start to invest you might be wondering what types of investments there are to put your money in, and what the risks and rewards are. The right investment for you will be dependent on several factors such as where you are personally and financially in life, what level of risk vs reward you want to take, and the level of financial education you have. In this article we will try to give you a broad overview of typical investment options.
So what types of investments are there?
- Savings Account
- Fixed Deposit (also called Time Deposit)
- Exchange-Traded Funds (ETF)
- Exchange-Traded Notes (ETN)
- Index Funds
- Mutual Funds
- Closed-end Funds
- Real Estate
Want to learn more about the different options and their investment profiles? Read on to find out.
One of the safest ways to invest your money is to put it onto a savings account with a bank. You can access and withdraw the money at any time. This is usually the right option if you just want to store the money over a few weeks or months before you use it. Opening a savings account is very easy, and can be done with little money. There are however savings accounts, on which you need to maintain a minimum amount, otherwise, the bank will charge something on a monthly or yearly basis.
You might get a very minimal amount of interest paid for the money you have in your account, but the amount is usually so small that it won’t really make that much of a difference. With this option, you won’t beat inflation, and so your money will lose some of its value over the long term.
The main risk is that if the Bank defaults, you could lose the money. However, most banks insure deposits up to a certain amount. So you can check with your bank, up to what amount your deposit is insured.
Fixed Deposit (also called Time Deposit)
If you know that you don’t need your money for a few months, or also years, but you fear investments, by which you are exposed to the volatility of the financial markets, then you can consider investing in a fixed deposit (sometimes also called time deposit) account. This is a special account type offered by Banks, in which you can pay money for a specific term length and receive interest payments from the bank. You lend the bank your money so that they can invest it into higher-yielding assets, such as lending the money to a company or investing it into stocks or other financial assets.
Once you have put the money into the fixed deposit account, it will be locked, and the money can only be withdrawn when the term ends. Usually, terms can reach from 1 month up to several years. The longer the term, the higher the interest you will receive from the bank, for letting them work with your money. There are usually options to withdraw the money before the end of the term period, but you won’t get any interest payments and might even have to pay a penalty for withdrawing the money early.
The positive thing is that you don’t have to take any risk, as you have a contract with the bank, for fixed interest payments over a specific term. The Bank will take the risk of investing your money and returning it to you together with the interest. If the Bank fails with its investment, it will still pay you the money including the interest.
The negative thing is, that even though the interest might be higher, you might still not beat inflation, and will therefore not necessarily end up with an adequate profit.
The main risk is that if the bank defaults, you could lose your money, unless the bank offers insurance, and if you need the money prior to the maturity of the term, you will lose the interest payments, and might have to pay a penalty.
Exchange-Traded Funds (ETFs)
An Exchange Traded Fund (ETF) is a collection of securities, that can be bought under one single ticker symbol on the stock market. ETFs are similar to stocks. In many cases, ETFs are mirroring indexes. One of the most famous indexes for example is the S&P500, which has 500 of the largest companies in its index. When you invest in an ETF that mirrors the S&P500 you buy a small part of all these 500 companies. An ETF today can consist of stocks, bonds, commodities, and even real estate. An ETF can be traded at any time during the day on the stock market, in the same way, a stock can be traded.
Because ETFs are usually passively managed and mirror an index of securities, or a market sector, they are cheaper than other similar options such as Mutual Funds.
ETFs will have market risks, which means that the price will go up and down with the market, same as stocks or bonds. As ETFs are the currently “hot kid on the block” several also rather exotic ETFs are being created, and if they don’t attract enough customers, they are closed down again. If an ETF is closed down, the underlying assets will be sold and you will receive back your money to the current ETF price. If the price is higher, you will have made some money, if the price is lower, you will have lost some money. There will be the usual transaction fees for selling the ETF and it might have some tax implications, depending on your country.
As ETFs are the hot topic out there, some ETFs were created that are leveraged, which means when you buy this ETF, you will also buy into a loan, to maximize your profits. However a leveraged product also has more downside risks, so if you’re not knowledgeable enough, stay away from these. Purchasing a Gold ETF for hedging purposes (as Gold usually goes up when stocks go down) can be good, but if you read the prospectus you will notice, that in many ETFs the custodian is not required to hold the full amount of Gold in real assets. In an emergency scenario, if you would want to get your Gold, it might not be available. If you want to invest in Gold other than for hedging purposes, you might be better off, to buy Gold from a local Bank.
ETFs have also a lot of benefits. They are low cost, you can purchase one single ETF if you want to, the initial amount you need to invest is very low. The money in ETFs, is held separately from the company, managing the ETF, which means, that when the company defaults, it will not directly affect your investment.
If you purchase an ETF that mirrors the S&P500 index for example, you will be well diversified, as you own a fraction of all of these large well established companies. Large well established companies are less likely to fail and will usually produce profits in the long run. But even if one company would default, it’s one five-hundreds piece of what you own, and such a company will be replaced by a new one that can deliver, without you having to lift a finger.
If you purchase popular ETFs from Vanguard, Fidelity, Blackrock or Charles Schwab, you’ll do usually just fine.
Exchange-Traded Notes (ETNs)
An ETN (Exchange Traded Note) is an unsecured debt note, usually issued by a bank or other financial institution for a certain term. It has therefore some similarities to an unsecured Bond. But unlike a Bond, ETNs don’t pay interest but provide investors with the returns of the underlying index or strategy at maturity of the term. An ETN can for example link to the S&P500 index. At maturity of the note, the investor will receive the returns of the assets held in the S&P500 index, inclusive of the dividends. The returns can be positive or negative based on the performance of the underlying assets, and the fees imposed by the issuer of the ETN.
It is important to note, that with an ETN the investor doesn’t own the underlying assets. An ETN is simply a promise from the underwriter (Bank or financial institution) to pay the investor the returns at maturity of the term. Therefore if the Bank or financial institution goes bankrupt, the investment can be fully lost.
ETNs are traded on public exchanges, and as such if the underwriter loses credit-worthiness (there are rating agencies such as Standard & Poor which rate the credit-worthiness of companies) this might have a negative impact on the price of the ETN.
One of the main advantages of ETNs is tax efficiency, as they are treated as long-term capital gains which are treated more favorably than short-term capital gains. Another main advantage is that because with ETNs the underlying assets aren’t owned by the investor, it is possible to link otherwise hard to reach markets to the ETN.
ETNs allow financial institutions to construct very complex products, that can consist of a mixture of leverage, futures, and other financial products. With ETNs, you will carry both, credit risk and market risk. If the product is leveraged, you will also additional carry the downside risk of the leveraged product. Additionally, ETNs are not as liquid as other financial products, which means that you might not be able to sell it that easily if you want to sell before maturity.
You should only invest in ETNs if you clearly understand the benefits and risks, and there is a clear advantage to other investment products.
There can be some confusion between Index Funds and ETFs. An Index Fund is simply a fund that tracks an underlying index, such as the S&P500. You can invest in an Index Fund through a Mutual Fund or through an Exchange Traded Fund (ETF).
Index mutual funds are usually cheaper than other mutual funds, as the fund manager doesn’t try to outperform the market. They are therefore passively managed. Usually there are no transaction costs involved with Index Mutual Funds, which can make them attractive in some cases.
In general ETFs usually cost less and are more tax efficient than index mutual funds. They can be traded under a single ticker symbol the same way as a stock on the stock exchange.
With a mutual fund you pool money with other investors to purchase a collection of stocks, bonds, commodities or other securities, which would be difficult to create on your own. A mutual fund is usually managed by a professional fund manager. The advantage of a mutual fund is, that it is professionally managed. Funds own their underlying assets, which means you are partial owner of these assets to the amount you contributed. As mutual funds usually hold a large amount of assets, you are well diversified, which reduces risk. Additionally the assets held are kept separate from the fund managing company, which means that if the company goes bankrupt, it will not affect your assets.
Mutual funds usually come with charges. The fund manager of the active mutual fund will usually cost 1-2% of the invested sum per year. There are usually also fees for entry and exit, and there might be a minimum investment amount, that is required to invest into the fund.
It is possible to buy and sell Mutual Fund shares at the end of day.
A closed-end fund is launched through an IPO (Initial Public Offering) to raise a fixed amount of money and is after that traded on the open market such as a stock or an ETF. The shares are therefore limited. As with a mutual fund, there is a professional fund manager that manages the fund. But no additional shares are issued by the fund company, after the IPO, and shares can’t be redeemed through the fund company. The shares of the fund will be traded on the stock exchange.
Closed-end funds usually offer higher returns and dividends than mutual funds. In the majority of the cases, closed-end funds are leveraged, to produce higher returns to its investors. As the funds are publicly traded on the market, they are subject to market fluctuations. It might be more difficult to sell a closed-end fund as if it doesn’t do that well, then there might not be that many buyers. As the underlying assets might be leveraged, there is the downside risk of the leverage.
Closed-end funds are usually rather catered to investors that want regular cashflow and gains, rather than capital appreciation.
A stock is a security that represents a share of a company. In order to raise money, private companies can get listed on the public stock exchange. This is called an IPO (Initial Public Offering). The IPO underwriters, which are usually employed by Banks will help to determine the initial stock price. They will contact their large network of investment organizations such as Hedge Funds, Pension Funds to evaluate their interest to purchase the stock. Once the initial offering has been determined, the underwriters will purchase the stocks and sell them on to these large investors. The underwrites also guarantee that a certain amount of stocks is sold, and will buy any surplus. This process is called the Primary Market. It’s where stocks get created and initially sold. This is where the company is receiving the money for issuing the shares.
After that the shares will be traded on the secondary market, also referred to as the stock market, to which NASDAQ, NYSE, and others belong to. Institutional and Retail investors can buy and sell stocks on the secondary market, if they agree to pay the asking price. Retail investors usually buy and sell stocks through a broker, such as a bank, insurance, or online broker firm.
By purchasing stocks the investor buys a share of the company. If the company does well, the stock price usually rises, and the company might pay dividends to the investors. When the company does not so well the stock price will usually fall, and the company might decide to suspend dividend payments to investors.
The price of the stock will depend on the companies management decisions, revenue, profit, sales, reserves, products, and competitors/moat. Investors look at the balance sheet of the company, join the annual shareholder meetings, and try to determine if the strategy to increase sales and market share is in line with their own analysis and views.
Stocks can be bought and sold at any time on the stock markets. If compared against mutual funds or ETFs, buying a single stock will have a higher risk. Therefore most investors buy stocks of different companies and build up their own stock Portfolio, which helps to diversify.
The advantage with purchasing stocks is, that you can target your investment specifically to companies you like and understand. The disadvantage is, that if one of these companies go bankrupt, you might lose a larger piece of your investment. You will have to spend much more time following the companies, and take active buy and sell decisions, whereas with a mutual fund or ETF you don’t need to take these decisions yourself.
Bonds are units of debt issued by corporations or the government. If the government or a company want to raise cash, they can issue bonds, which are sold to investors. Bonds are IOUs that have a defined term, usually from 1 month up to several years. Investors that purchase these bonds receive interest payments, either on regular bases during the term, or accumulated at the end of the term.
Bonds are considered to be more secure than stocks, as the investors don’t have market risk. However, if a company issues the bonds, the company could go bankrupt. If this happens then the investor will lose his investment or get back a part of the cash, if there are remainders after the company has been liquidated. There are rating agencies such as Standard & Poor’s, Moody’s, and Fitch, which rate companies based on their creditworthiness, where AAA is the best rating, and C and D are the worst ratings. Everything below Standard & Poor’s, or Fitch’s BBB, or Moody’s Baa, is called a junk bond.
Investors don’t need to hold the bonds to their maturity and can buy and sell bonds on an exchange.
An annuity is a contract between an investor and an insurance company. The investor invests a lump-sum or conducts regular payments and in return receives regular disbursements paid out immediately, or in the future. During the time the funds are with the insurer, the insurer invests the money, and the investor receives a percentage of the investment gains added to his capital throughout the investment. This kind of investment is mainly useful for retirees who want to ensure a regular cashflow. The income received is taxed as regular income tax.
The investor can decide on the duration of disbursements if they should be capped at a certain number of years or lifetime. If lifetime that usually means that the disbursed payments are lower.
There are fixed, variable, and indexed annuities.
- Fixed annuities will guarantee a fixed amount being paid out, but because there is a guarantee, usually the percentage of investment gains paid out is smaller.
- Variable annuities can offer higher returns but with also higher risks. Usually, the investor can define in which mutual funds the money should be invested.
- Indexed annuities usually offer a guaranteed minimum payout, with medium risk, but also less percentage of investment gains.
While annuities can offer protection against overspending, the fees are generally rather on the high side, and the investment gains shared with the investor rather on the low side. Additionally, the disbursements are taxed as income, which is usually higher, than just putting the money into mutual funds where the money will be taxed as long term capital gain tax.
Therefore this might not be for people that are generally up to speed with their cost and are able to plan their monthly withdrawals by themselves.
There are several ways an investor can invest in real estate. Real estate is usually considered a generally secure investment, however, when taking leverage, there is risk that needs to be understood.
The most common way to invest in real estate is to make a downpayment between 5% up to 30% of the property price and take a mortgage (housing loan), which is usually lent by a bank. Either the investor lives in his property and therefore pays of his property by himself, or the investor rents the property out, and becomes a landlord. If the investor rents out the property, he speculates that the tenant will pay off the debt of the property, and if the investor is lucky, there might be some surplus after deducting the interest and payment to the bank.
Other investors might speculate on undervalued real estate prices of properties, that need to be fixed up. They purchase the property to an undervalued price, renovate the property and then sell it at a premium to the new value.
Another option to invest into real estate is through a Real Estate Investment Group (REIG). Usually a company purchases, renovates, or builds apartment blocks or houses, and then offers the units to the investors, which can own one or several units. The group however collectively manages all the properties, including the rental, advertisement and maintenance. For doing that the group gets a percentage of the monthly rent. The units are usually pooled, which means that vacancies are carried by all investors, and therefore their income might be temporarily lower. On the positive side, investors also receive payments, if their own unit is vacant.
A real estate investment trust (REIT) is a good option for investors, that want to be exposed to real estate, but don’t want, or can’t afford to purchase a full property. A real estate investment trust has to pay out a fixed percentage, usually up to 90% of the income as dividends.
A corporation or trust will buy real estate income properties with money from investors. These REITS can then be bought and sold on a public exchange like stocks. With REITS retail investors are able to not only invest into housing properties, but also into malls and office buildings.
REITS are therefore loved by investors as income stocks, with which they get a regular cashflow. Is is to mention that there are not only equity REITs but also mortgage REITS, that lend money to buyers. The investor will have to decide which REITs he prefers to invest in.
Real estate Crowd Funding is usually offered through online platforms, where investors are joined up with real estate developers, that require funding for a real estate project. The investments can be diversified into several projects and the sums are usually not very high. The deals however will only be established once enough investors committed to fund the real estate.
You can also invest in a business directly. If you have read the Stock and Bond sections, you have already some knowledge of how you can invest in a business. You can either buy a share of a business, by providing equity, which means you will purchase a part of the company, or you can loan the company money, either through a direct contract or a bond. A small business won’t trade on public exchanges, hence it will be a direct investment.
If you buy shares of the business you’ll have to deal with the owners, how much percentage of the company you will get for your investment. If you for example invest $100’000 and $900’000 comes from other investors, then you could argue that you want 10% stake in the company, as you have provided 10% of equity. But other agreements are possible, and in the end it has to be a win/win situation for all involved parties.
If you loan the company money, the company will pay you interest on the loan. You will have no stake in the company. If the company goes bankrupt, you will have a right to paid out first, after the companies assets have been liquidated, but if the company doesn’t have any valuable assets to sell, you might lose all your money.
There are some additional types of investments, which are a little more speculative in nature, into which we will not go into detail in this article, we might cover them at a later stage:
- Commodities Trading
- Currency Trading
- Options Trading
- Futures Trading
- Crypto Trading