What Types of Investments Should I Have In My Portfolio?
When it comes to investing, there are a variety of different options to choose from. Each option has its own unique risks and rewards, so it’s important to understand the differences before making a decision.
Though it can be a scary proposition for those who are just getting started, investing your money is one of the best ways to grow it over time.
Here is an overview of the most common types of investments.
Why Invest Money?
Investments let you get more use out of your money. Whether you’re saving for retirement or trying to grow your wealth, most investments will yield more than parking your money in a savings account.
Benefits of investing include:
- Growing your wealth by taking advantage of compound interest.
- Securing your future with a healthy retirement account.
- Reducing your taxable income each year by putting money into an IRA.
- Increasing your chances of early retirement.
What Are the Different Ways to Invest Money?
Luckily, there are many great ways to invest money that will grow your wealth and save for your future.
There are several primary investment types that stand out, and not all of them involve the stock market and high risk. If you’re the cautious type, that’s good news.
Stocks go with investments like peanut butter goes with jelly. Stock is probably what comes to mind as soon as you hear the word “invest”.
By purchasing stocks, you’re buying a small piece of a company. The money you put in can either increase or decrease depending on how well that company profits.
The stock market is very unpredictable; it’s a high-risk investment that can produce lots of profit or cause plenty of loss. Since the market fluctuates daily, that’s particularly scary for investors who don’t like risk.
Advantages of Stocks:
- Investing in quality stocks and holding them for long periods of time can produce high profits for shareholders.
- If you don’t have the itch to buy and sell frequently, it’s likely that you’ll come out with a good amount of investment growth over the long haul.
Risk involved: Stocks carry considerable risk since no one knows when a given company will profit or tank in any certain timeframe. An expected return isn’t easy to predict.
Where to invest: Open a brokerage account to purchase stocks.
Investing in bonds is very much like receiving an IOU from a government or corporate entity. An investor loans money to help with project financing, operating expenses, or refinancing debt.
In exchange, the holder of the bond earns annual interest on the amount loaned. The interest, as well as the pay-back date, are set when the bond is purchased.
Advantages of Bonds:
- Adding bonds to your investment portfolio balances the risk factor of stocks.
- Your expected return is predictable since it’s based on a predetermined interest rate.
- You’ll get your money back on the investment when the bond matures.
Risk involved: The investment risk is very low. However, bond values fall whenever interest rates rise so it’s a good idea to hold a variety of stocks and bonds to ensure a healthy mix of earning power in your portfolio.
Where to invest: Find a broker or purchase a government bond directly from the government.
A mutual fund is like a pie baked with a variety of financial assets. There might be a sprinkle of bonds, a good amount of stocks, and a few commodities thrown in for a balanced final product.
The fund brokerage uses investors’ money to buy the ingredients (financial assets that go into the fund). The brokerage owns the ingredients, but the investors own pieces of the pie.
This type of investment fund provides excellent asset allocation—which is a fancy term for not putting all of your eggs in one basket. If one part of the recipe doesn’t perform well, you’ve got several others to bank on.
Advantages of Mutual Funds:
- It’s safer than buying individual stocks.
- There are numerous combinations of investment types and industry sectors to choose from.
- This investment is overseen by a special manager who carefully evaluates fund performance and makes regular adjustments to maximize returns.
This is a managed fund and is therefore more costly. However, fund managers are always trying to outperform the general market. So sometimes your profits will be higher and can offset these costs.
Risk involved: Mutual funds aren’t necessarily considered risky. But if you have a high allocation of stocks in a fund, losses could definitely result. The risk is dependent on what your fund is made up of.
This investment is like a mutual fund, but its purpose is to mirror the performance of top-performing companies in the market. The most popular index is the S&P 500 which follows 500 large top-performing companies in the U.S. stock market.
Advantages of Index Funds:
- Fees are lower since there’s very little hands-on management.
- Index funds tend to perform well without much fuss.
- S&P 500 investments historically yield profitable returns on a steady basis.
- Index funds are generally considered low risk.
Where to invest: Join a low-cost brokerage firm so you can earn steady returns over the long haul.
Exchange Traded Funds
This is another type of collective investment that pools the money of many investors together to buy a diversity of financial assets.
There are many different configurations you can choose from. You could invest in a mix of stocks and bonds, or shares in a certain industry. And like an index fund, you can purchase shares in an ETF that follows the S&P 500.
Unlike mutual funds, ETFs can be bought and sold throughout the day just like stocks on a daily exchange. And you can find many ETFs without costly management fees.
Advantages of ETFs:
- You won’t need a ton of money to invest. You’re allowed to buy a single share if you want to start out small.
- Most ETFs don’t have management fees.
- You can invest in a wide range of markets so your investment portfolio is nicely diversified.
- Some ETFs offer dividends that provide regular cash payouts.
Risk involved: ETFs are generally low risk. But some growth investment ETFs can be quite risky due to investing in small unproven companies. Your capital gain could either skyrocket or vanish.
Where to invest: Open an account with a brokerage firm to purchase ETF funds.
Real Estate Investments
This type of investing involves either renting out housing or land that you own or owning shares of property. The kind of real estate investing that you choose depends on you. If the thought of owning and managing property sounds stressful, you can opt for the more hands-off option.
Residential Real Estate Investments
This involves purchasing property the same way you’d buy your own house. By doing careful research and buying where people need housing, it’s possible to rent a property and make a profit.
Another common practice is to buy a home that needs TLC, fix it up, list it for a higher price (being careful to cover improvement costs) and hopefully make a nice profit.
Residential investing can require a good bit of upfront cash for purchase, and you’ll need to qualify for a mortgage with a lender.
Risk involved: Real estate investing can be quite risky. Research the various risks carefully and work with a qualified real estate agent.
Where to invest: Contact a real estate agent to help you find and purchase a property.
Commercial Real Estate Investing
Investing in commercial real estate means buying property that’s used for business purposes such as warehouses, co-working spaces, shopping malls, and retail stores.
Commercial investing can yield big profits, but it also requires large amounts of cash for a down payment and adequate qualifications for a large loan.
Risk involved: Like personal real estate, commercial properties come with high risk. There can be wild swings in property values, you may have trouble renting it, and there’s no guarantee of getting your money back after selling.
Where to invest: Contact a commercial real estate agent to help you find and purchase a property.
Real Estate Investment Trust
Otherwise known as an REIT, this is a hands-off form of real estate investing. This is the promised hands-off approach! You won’t own physical property, but rather shares in companies who own large commercial properties such as malls, resorts, and hotels.
REITs don’t require a huge amount of upfront capital unlike physical real estate investments. These investments are more fluid and flexible, where you can simply sell them on the stock exchange if you need to cash out quickly. You’re almost guaranteed to make some money as these funds are required to share 90% of profits with investors.
Risk involved: REITs are generally less volatile than owning physical real estate, but they’re not risk-free. Although the dividends can be very lucrative, they’re also likely to fall when interest rates go up.
Where to invest: Find a brokerage that offers mutual funds with REITs.
While not exactly a different type of investment, retirement accounts provide another way of investing in a variety of assets.
The main difference between a retirement account and the other investment types are certain tax advantages.
Individual Retirement Account (IRA)
With an IRA, you can buy mutual funds, ETFs, index funds, and more to set aside for retirement. IRAs are meant to buy and hold over the course of many years so they can grow large amounts of interest.
- An IRA is funded with money before it’s taxed so you’ll pay on that money when you use it at retirement age.
- At tax time, you can claim a deduction on your contributions for the year.
- You can withdraw money without penalties at age 59 ½.
- The max yearly contribution amount is $6000 per year (or $7000 if you’re over 50).
A Roth IRA is another type of individual retirement account that’s similar to a traditional IRA, but with a few differences.
- A Roth IRA is funded with taxed dollars which means you’ll pay no tax when it’s time to withdraw for retirement.
- You can’t claim a tax deduction on these contributions.
- You can withdraw cash from a Roth IRA account (only the principal you’ve contributed, not the interest) at any age without penalty.
- The maximum contribution each year is $6,000 ($7,000 if you’ve over 50).
A 401(k) is an employer-sponsored retirement account. Usually, as an incentive to encourage employees to save for retirement, employers will kick in some of their own money to match your contributions.
Bottom Line for Investment Types
As you can see, there’s no shortage of ways to invest your hard-earned cash for growing wealth and saving for retirement.
The investment methods you choose will be very individual and depend on personalized things such as how much you have to invest and what risks you’re willing to take. It’s always recommended to get investment advice from a qualified professional.