Investing Explained: Types of Investments and How To Get Started

The act of investing is the distribution of resources, typically capital, with the hope of producing income, gains, or profits. It entails investing money over a period of time in a certain project or business in order to produce profits.

Money can be used for a variety of endeavors, including starting a business and purchasing real estate. Knowing that risk and return are inversely correlated—low risk typically translates into low predicted returns, whereas higher returns are typically accompanied by increased risk—is essential to understanding investment.

Understanding Investment

Investing means making money grow over time. The expectation of a positive return in the form of statistically significant income or price appreciation is the fundamental premise of investing. The spectrum of assets in which to invest and earn a return is very broad.

In investing, risk and return go hand in hand; low risk typically translates to low expected returns, while higher risk typically translates to higher returns. At the low risk end of the spectrum are basic investments such as certificates of deposit (CDs): bonds or fixed income instruments are higher on the risk scale, while stocks or equities are considered riskier. Commodities and derivatives are often considered the riskiest investments. You can also invest in something practical, such as land or real estate, or in delicate objects, such as works of art and antiques.

Never invest in a business you can’t understand.

Warren Buffet

Risk and return expectations can vary widely within the same asset class. For example, a blue chip listed on the New York Stock Exchange will have a very different risk return profile than a micro cap listed on a small exchange.

The returns generated by an asset depend on the type of asset. For example, many stocks pay dividends quarterly, while bonds usually pay interest every quarter. In many jurisdictions, different types of income are taxed at different rates.

In addition to regular income, such as dividends or interest, price appreciation is an important component of profitability. Thus, the total return for all types of investments can be considered the sum of income and capital appreciation. Standard & Poor’s estimates that, since 1926, dividends have contributed nearly one third of the total return of S&P 500 stocks, while capital gains have contributed two thirds. Capital gains are therefore an important piece of the investment.

Economists consider investing and saving to be two sides of the same coin. This is because when you save money by depositing it in a bank, the bank lends that money to individuals or companies who want to borrow it to put it to good use. Therefore, your savings are often someone else’s investment.

Types of Investments

Today, investment is mainly associated with financial instruments that allow individuals or companies to raise and provide capital to companies. These companies then collect this capital and use it for growth or profit generating activities.

Although the universe of investments is very broad, here are the most common types of investments:

Shares | Types of Investment

The purchaser of a company’s shares becomes a fractional owner of the company. Owners of a company’s stock are called shareholders and can participate in its growth and success through share price appreciation and periodic dividend payments out of the company’s profits.

Bonds | Types of Investment

Bonds are debt obligations of entities such as governments, municipalities and corporations. Buying a bond means that you own a portion of an entity’s debt and are entitled to receive periodic interest payments and repayment of the face value of the bond when it matures.

Funds | Types of Investment

Funds are pooled instruments managed by investment managers that allow investors to invest in stocks, bonds, preferred stocks, commodities, etc. Two of the most common types of investment of funds are mutual funds and exchange traded funds or ETFs. Mutual funds are not listed on an exchange and are valued at the end of the trading day; ETFs are listed on an exchange and, like stocks, are constantly valued throughout the trading day. Mutual funds and ETFs can passively track indexes, such as the S&P 500 or the Dow Jones Industrial Average, or they can be actively managed by fund managers.

Investment Funds | Types of Investment

Trusts are another type of pooled investment. Real estate investment trusts (REITs) are one of the most popular in this category. REITs invest in commercial or residential properties and pay periodic distributions to their investors from the rental income received from these properties. REITs are publicly traded, so they offer their investors the advantage of instant liquidity.

Alternative Investments | Types of Investment

Alternative investments are a general category that includes hedge funds and private equity. Hedge funds are so called because they can hedge their investment bets by going long and short on stocks and other investments. Private equity allows companies to raise capital without going public. Hedge funds and private equity used to be available to wealthy investors considered “accredited investors” who met certain income and net worth requirements. In recent years, however, alternative types of investments have been introduced in fund formats accessible to retail investors.

Options and Other Derivatives

Derivatives are financial instruments that derive their value from another instrument, such as a stock or an index. Option contracts are a popular derivative that give the buyer the right, but not the obligation, to buy or sell a security at a fixed price within a specified time frame. Derivatives often employ leverage, making them a high risk, high reward proposition.

Raw Materials

Commodities include metals, oil, grains and animal products, as well as financial instruments and currencies. They can be traded through commodity futures which are agreements to buy or sell a specific quantity of a commodity at a specific price at a specific future date or ETFs. Commodities can be used to hedge risks or for speculative purposes.

Comparison of Investment Styles & Types of Investment

Let’s compare a couple of the most common investment styles:

• Active versus passive investing: The objective of active investing is to “beat the index” by actively managing the investment portfolio. Passive investing, on the other hand, advocates a passive approach, such as buying an index fund, in tacit recognition of the fact that it is difficult to beat the market consistently. While both approaches have their pros and cons, few fund managers actually beat their benchmarks regularly enough to justify the higher costs of active management.
• Growth vs. value: Growth investors prefer to invest in high growth companies, which tend to have higher valuation ratios, such as price to earnings (P/E), than value companies. Value investors seek companies with significantly lower P/E and higher dividend yields than growth companies, as they may fall out of favor with investors, either temporarily or over an extended period.

How to Invest | Types of investments

Investing on Your Own Account

The question of “how to invest” comes down to whether you are a do it yourself (DIY) investor or prefer to have your money managed by a professional. Many investors who prefer to manage their money themselves have accounts with online or discount brokerages because of their low commissions and ease of executing trades on their platforms.

DIY investing is sometimes called self directed investing, and it requires a good deal of education, skill, time commitment, and the ability to control one’s emotions. If these attributes don’t describe you well, it may be smarter to let a professional help you manage your investments.

Professionally Managed Investment | Types of Investment

Investors who prefer professional management of their money often have wealth managers handle their investments. Wealth managers typically charge their clients a percentage of assets under management (AUM) as a fee. Although professional money management is more expensive than managing it yourself, these investors don’t mind paying for the convenience of delegating research, investment decision making and negotiation to an expert.

The SEC’s Office of Investor Education and Advocacy urges investors to confirm that their investment professional is licensed and registered.

Roboadvisor Investment

Some investors choose to invest by following the suggestions of automated financial advisors. Using algorithms and artificial intelligence, robo advisors gather essential information about the investor and his or her risk profile to make appropriate recommendations.

With almost no human intervention, robo advisors offer a cost effective way to invest with services similar to those of a human investment advisor. With advances in technology, robo advisors can do more than just screen investments. They can also help individuals develop retirement plans and manage trusts and other retirement accounts, such as 401(k)s.

Brief History of the Investment & Types of Investment

Although the concept of investing has been around for millennia, investing in its current form has its roots in the period between the 17th and 18th centuries, when the development of the first public markets brought investors into contact with investment opportunities. The Amsterdam Stock Exchange was established in 1602, and the New York Stock Exchange (NYSE) in 1792.

Investment in the Industrial Revolution

The Industrial Revolutions of 1760-1840 and 1860-1914 led to increased prosperity, as a result of which people accumulated savings that could be invested, encouraging the development of an advanced banking system. Most of the established banks that dominate the investment world began in the 19th century, including Goldman Sachs and J.P. Morgan.

Investment in the 20th Century

The 20th century broke new ground in investment theory, with the development of new concepts in asset pricing, portfolio theory and risk management. The second half of the 20th century saw the introduction of many new investment vehicles, such as hedge funds, private equity, venture capital, REITs and ETFs.In the 1990s, the rapid spread of the Internet brought online trading and research capabilities within reach of the general public, completing the democratization of investment that had begun more than a century earlier.

Investing in the 21st Century

The bursting of the dot.com bubble a bubble that created a new generation of millionaires from investments in technology and online stocks ushered in the 21st century and perhaps set the stage for what was to come. In 2001, the collapse of Enron took center stage, with its unfolding fraud that bankrupted the company and its accounting firm, Arthur Andersen, as well as many of its investors.

One of the most remarkable events of the 21st century, or of history for that matter, is the Great Recession (2007-2009), when an overwhelming number of failed investments in mortgage backed securities crippled economies around the world. Renowned banks and investment firms collapsed, foreclosures multiplied and the wealth gap widened.

The 21st century also opened up the investment world to newcomers and unconventional investors by saturating the market with discounted online investment companies and free investment apps, such as Robinhood.

Investment versus Speculation | Types of Investment

The qualification of the purchase of a security as an investment or speculation depends on three factors:

• The level of risk assumed: Investing usually involves less risk than speculating.
• The holding period of the investment: Investing usually involves a longer holding period, often measured in years; speculating involves much shorter holding periods.
• Source of returns: Price appreciation may be a relatively less important part of investment returns, while dividends or distributions may be an important part. In speculation, price appreciation is usually the main source of returns.

Since price volatility is a common measure of risk, it stands to reason that a stable blue chip is much less risky than a cryptocurrency. Therefore, buying a blue chip that pays dividends with the expectation of holding it for several years would be considered an investment. On the other hand, a trader who buys a cryptocurrency to make a quick profit in a couple of days is clearly speculating.

Example of Return on Investment | Types of Investment

Suppose you bought 100 shares of XYZ stock for $310 and sold them exactly one year later for $460.20. What was your approximate total return, excluding commissions? Note that XYZ does not distribute stock dividends. The resulting capital gain would be (($460.20 – $310)/$310) x 100% = 48.5%.Now, imagine that XYZ had issued dividends during your holding period, and you received $5 in dividends per share. Your approximate total return would then be 50.11% (Capital gains: 48.5% + Dividends: ($500/31,000) x 100% = 1.61%).

Wrap Up | Types of Investments

Investing is the act of allocating resources into something to generate income or profit. The types of investments you choose will probably depend on what you are seeking to earn and how sensitive you are to risk. Taking low risk usually results in lower returns and vice versa in the case of taking high risk. You can invest in stocks, bonds, real estate, precious metals and much more. You can invest with money, assets, cryptocurrencies or other means of exchange.

There are different types of investment instruments, such as stocks, bonds, mutual funds and real estate, each of which carries different levels of risks and rewards.Investors can invest independently without the help of an investment professional or engage the services of a licensed and registered investment advisor. Technology has also given investors the option of receiving automated investment solutions through roboadvisors.

The amount of consideration, or money, required to invest depends largely on the types of investments and the investor’s financial situation, needs and objectives. However, many vehicles have lowered their minimum investment requirements, allowing more people to participate.

Regardless of how you decide to invest or what you decide to invest in, research your target as well as your investment manager or platform. Possibly one of the best nuggets of wisdom is from veteran and accomplished investor Warren Buffet: “Never invest in a business you can’t understand.”

FAQs | Types of Investments