In most cases, the best way to begin investing is to decide which asset classes you want to own. There are three to choose from: real estate, stocks, and fixed income (bonds). Each has its own risks, opportunities, and tax rules. While building a complete portfolio might seem complex, the dividends, interest, and rents can be worth it.
You will tend to lean toward asset classes based on what you know and need at that time. When your life changes and as you age, your needs change. You'll go from needing growth to needing a stable income. Different types of assets can meet these changing needs.
Here are some details on the three classes to help you decide how to begin investing and saving.
- The three classes of investments are owning a business (stocks), money lending (bonds and loans), and real estate.
- Buying stocks is one of the most common ways people start investing.
- Buying a home and renting it is one way you can break into the real estate market.
- Loaning money with terms and interest, buying bonds, or funding a peer loan are ways you can get into money lending.
Acquiring an Ownership Stake in a Business
Owning a business (or parts of one) has been a great way to build wealth in the past. You don't have to be the original owner; purchasing stocks are one of the most common methods of ownership. You can buy the stock(s) of a business in many ways.
Buy Stock in a Publicly Traded Business
You can buy common stock by trading on an exchange such as the New York Stock Exchange (NYSE). You can invest through your broker, 401(k) plan, individual retirement account (IRA), direct stock purchase plans, or mutual fund accounts.
An easy way to pick up a stake in a business is to purchase some of its stock.
Start Your Own Company
You can start your own business and form it in one of many different ways. If you have the talent, skill, and drive, starting your own business is often more profitable than buying a stock.
Buy Into Someone Else's Privately Held Company
You could become a partner or buy into a private company. There are several ways to do this—use cash, offer your labor, or negotiate some terms. Some investors focus on private equity and restrict themselves to sectors of the market where they feel like they have an advantage.
Lending Your Savings
Money lending is as old as civilization. You save up as much as you can and start making loans to others. You ask for interest on the loan based on its risk and term length. Bonds are also a form of money lending, but you're lending to a business. You lend them money, and they pay a coupon (interest) rate and give you your money back at the end of the term.
Bonds are debt issued by governments (such as Treasury bonds or savings bonds) or businesses. They can also be issued by municipalities, corporations, nonprofits, or other entities. You can buy bonds and bond funds through a broker.
There are many ways to lend money and receive interest, but one of the easiest for new investors is buying bonds or bond funds.
Make a Loan
You can make a direct loan by privately negotiating with someone who needs money. You might use a written or verbal contract that details the terms, conditions, a repayment schedule, and the interest rate.
The compound yearly growth rate you can earn when lending money depends on your skill with interest rates and payment schedules.
When you buy a certificate of deposit (CD), the bank or other financial institution offers you interest in exchange for your deposit. If you buy CDs, you'll need to leave that money in place for a certain amount of time.
Investing Money in Real Estate
Behind lending money, owning real estate is among the oldest financial money-making activities. If you own land or a house, you can make money by renting it to someone.
In the modern economy, there are several ways to acquire real estate for your investments. These are only a few.
Purchase a Home
Buying a home for your family falls more along the lines of cost reduction than investing. However, home values rise and fall similar to stock. You can buy a house for $100,000 one year and see its value increase to $120,000 the next. This is an increase of $20,000 in equity over one year.
You can also buy a house to rent it out to families that cannot afford a home loan. A lease-purchase contract is an agreement between an owner and buyer. The buyer pays an option fee to secure the right to buy the home at a later date at a set price. The seller leases them the house until they purchase it, hoping to make money on the lease payments and when the home is sold.
For example, say you bought some homes that you rent out on lease-to-own terms to families who couldn't qualify for a mortgage. After adjusting for various factors such as taxes and maintenance, your cap rate is 13%. That's a much better return than 2% interest for a CD, or the 0.10% offered on savings bonds.
When evaluating real estate, the "cap rate" (or capitalization rate) helps you figure out how much profit a property can make. To find the cap rate (a percentage), divide the property's net operating income by its current market value.
Flipping and REITs
Another method of real estate investing is to buy a home, improve it, and then sell it for more. This is called "flipping" and is very common in real estate.
Many people make money on homes by putting money down with other investors to buy real estate through special tax-advantaged businesses exempt from corporate taxes (under most circumstances).
Businesses that pool money to invest in real estate this way are known as Real Estate Investment Trusts (REIT). You can often acquire them like any other stock through a brokerage account. There are even ETFs and mutual funds that specialize in REITs, and you can buy them like any other equity.