The Basics of Investing

The Ins and Outs of Different Types of Investments

Image shows a stack of stock documents, a bond, a few monopoly homes, a large preferred stock, and a few jars with coins in them. Text reads: "The five types of assets you might own when you invest: common stocks, bonds, real estate investment trusts, preferred stocks, money markets"

The Balance / Chloe Giroux

Learning the basics of investing is like learning a new language. It is easy to get lost or feel overwhelmed. The good news is that once you have mastered certain investing basics, you'll better understand how your money is being invested for your future plans. To assist you on that journey, here is a look at the handful of the most common types of investments you will encounter in your lifetime: stocks and bonds, mutual funds, and real estate.

Key Takeaways

  • Stocks are good investments for investors who are willing to take risks for larger gains.
  • Bonds are less risky than stocks, and they offer a steady stream of income.
  • Mutual funds automate diversification, allowing any investor to access professional portfolio-balancing strategies.
  • Alternative investments, like real estate, hedge funds, and family businesses, may suit an investor's specific goals, but they come with a unique set of risks and rewards that vary widely by circumstance.

Finding the Right Mix for You

The world of investing offers a seemingly endless number of assets and opportunities. There are financial securities, which include stocks and bonds. You also have real assets, which are physical assets you can see and touch. Then you have assets that are bundled together into what's called a "fund." We'll walk through stocks, bonds, real estate, mutual funds, and other investing structures and entities.

The assets that are right for you will depend on many factors, such as your investment time frame, appetite for risk, and financial goals. Situations and preferences change with time, so it's good to re-evaluate your strategy as your circumstances evolve.

Buying Stocks

Without a doubt, owning stocks has been the best way, historically, to build wealth. Stocks are shares of ownership in a specific corporation. When you own a share of Apple, for example, you own a tiny piece of that company. Stock prices fluctuate with a company's fortunes and also with the economy at large.

These investments can be valued and rated, depending on the underlying company's financial stability. Some stocks pay a regular return of company profits in the form of dividends, and others do not. Investors can realize capital gains if the shares appreciate in value above what they paid for them.

If you sell an investment for more than you paid for it, you'll be required to pay capital gains tax on the profits if it is held in a taxable account.

Best For: Stocks are a great choice for investors who are aiming for higher returns, have a higher risk tolerance, and have faith in the success of companies.

Purchasing Bonds

When you buy a bond, you are lending money to the company or institution that issued it. Bonds are debt securities and can be in the form of Treasuries, municipal bonds, corporate bonds, and other types of debt. Until they pay you back, the borrower will pay you interest on a regular basis. Bonds have to be held for a period of time before they mature. However, you can resell them on the secondary market through your broker.

Best For: Bonds are best for investors who have a lower tolerance for risk and seek out less volatility in their investments. Bonds also offer consistent payments.

Putting Money in Mutual Funds

One of the most popular ways to own stocks and bonds is through mutual funds. Mutual funds are pooled money investments that will have a primary focus. In fact, most people are statistically less likely to own individual investments than they are shares of companies through mutual funds held in their 401(k) or Roth IRA.

Mutual funds offer many benefits to investors, particularly to beginners who are just mastering investing basics. However, mutual funds also have a few serious drawbacks: They charge fees, which can eat into your profits, and with some funds they may boost your tax bill, even in a year when you don't sell shares.

In most cases, there is a broker fee to buy or sell mutual fund holdings.

Best For: Mutual funds are a good fit for investors who want a diverse portfolio without the hassle of managing their investments.

Investing in Real Estate

Yes, you can buy a home for yourself or properties to rent, or you can purchase securities such as a real estate investment trust (REIT). REITs have a structure much like a mutual fund, where a professional manager handles the individual assets held within the trust's portfolio. However, with a REIT, all of the investments are only in real estate.

Best For: Real estate is best for those investors who are interested in real assets and have the experience to make the right picks. Investing in real estate without knowledge of the asset, location, and regulations could lead to headaches and a poorly performing asset.

Other Investing Structures and Entities

When you move beyond stocks, bonds, mutual funds, and real estate, you encounter different types of investment entities. For example, millions of people will never own a share of stock or a bond. Instead, they invest their money in a family business, such as a restaurant, retail shop, or rental property.

More experienced investors tend to invest in hedge funds or private equity funds or trade in futures and options contracts. Others will buy shares of publicly traded limited partnerships through their broker.

Investing Through the Ups and Downs

When bad things happen to your investments or savings, you don't need to panic. Sometimes, you need to take a hit before you can make some money again, and holding on until the downturn ends is often the best plan.

Even though there are thousands of investments available to any individual, some strategies have stood the test of time. Some basics include buying and holding long-term, diversifying, dollar-cost averaging, and choosing quality funds with the lowest fees.

Besides reading and learning as much as you can, one of the best things you can do is talk to a financial planner or accountant who can help you better understand the world of investing.