At its core, investing is the allocation of money into stocks, goods and other assets with the goal of generating more money in the future. With the right approach, investing can help you gain capital to fund retirement, pay for your children’s college expenses and tackle other financial goals. Investing is a powerful strategy for both preserving and growing wealth, but it does carry some risks.
While bank deposits are backed by federal deposit insurance, investments – like stocks, bonds and mutual funds – rise and fall in value according to the current market. There is no guarantee that you will profit from your investments, but research, patience and strategy can greatly help improve your odds of achieving favorable outcomes. If you are considering dedicating some of your money to investments, check out the guides below. Find out how to invest your money strategically by discovering common types of investments, learning about investing in riskier assets and reviewing other expert tips.
Of all the investment varieties, owning stocks is one of the most effective ways to build capital. Stocks, sometimes called equities, represent shares of ownership in a business. When you invest in stock, you become a co-owner of the business and gain certain shareholder rights, such as a vote at shareholder meetings and a percentage of company earnings.
There are two primary ways to make money on stocks:
- Dividend income is payment the company may provide to shareholders after the business makes a profit.
- Capital gain occurs when you sell your share of stock at a higher price than you paid for it.
Because stock prices rise and fall according to the company’s performance, the economy and market conditions, this type of investment is considered relatively volatile. However, because of their high risks, stocks have a higher return potential.
Bonds, sometimes called “fixed-income investments”, are an investment in debt obligation. Companies and governments, including the U.S. federal government, states, cities and counties, issue bonds to raise money for projects and other needs.
While you buy a share of company ownership when you purchase stock, with bonds, you lend money to the bond issuer. In exchange, the borrower promises to repay you after a certain period. In the meantime, the bond issuer typically pays you interest in the form of regular payments called the “coupon” or “yield.” Because investing in debt is safer than investing in equity, bonds are generally considered a safer investment than most stocks. Consequently, bonds typically carry a low rate of return.
For many individual investors, mutual funds present an attractive introduction into the world of investment. A mutual fund is a portfolio of stock, bonds and other securities funded by money from thousands of different investors, thereby giving them greater purchasing power that they would have had investing individually.
A professional fund manager, who dedicates his or her expertise to analyzing market conditions and researching companies to make wise investment decisions according to the fund’s goal, closely supervises mutual funds. A mutual fund’s goals may depend on its type. There are four primary types of mutual funds, including:
- Equity funds made up of primarily stocks.
- Fixed-income funds that consist of low-risk corporate or government bonds.
- Money market funds comprised of specific kinds of risk-free, short-term investments issued by the government of U.S. corporations.
- Balanced funds featuring of a combination of stocks, bonds and occasionally money market funds.
Because mutual funds are diversified – meaning they are spread across many different types of investments – and come with the management of a dedicated finance professional, this type of investment is a smart choice for investors lacking the time or expertise needed to monitor a portfolio. However, as with all types of investments, mutual funds carry the potential to lose money if securities inside the fund fall in value.
Other Types of Investments
Though stocks, bonds and mutual funds are the most common, there are many other ways to invest your money. Other types of investments include:
- Cash equivalents like certificates of deposits (CD) or money market funds.
- Real estate, including housing and commercial buildings that you may purchase to rent or fix up and resell.
- Real estate investment trusts (REITs), or shares in companies that invest in income-generating real estate.
- Hedge funds, which function like mutual funds but require a very large initial investment.
- Venture capital, or direct investments in seed-, early or growth-stage startups.
- Real asset investments in gold and precious metals, art, collectables and other tangible goods.
Investing in Riskier Assets
Investing in riskier assets is a strategy some investors may employ in pursuit of high capital gains won in a short period of time. “Risky” assets are associated with a higher chance of loss but may also carry a higher expected return. Examples of riskier assets include:
- Initial public offerings (IPOs), or a company’s first sale of stock to the public.
- Stock options, or a contract that gives you the right to buy or sell a stock at a predetermined price within a certain time frame.
- Foreign currency investing, sometimes called currency trading or forex trading, which is the exchange of one country’s currency for another.
- High-yield bonds, a type of bond that carries a higher risk of default but also higher coupons and potential for price appreciation than other types of bonds.
For the prepared, dedicated and informed investor, high-risk investing could carry potential for dramatic returns. Whether or not you should invest in high-risk assets depends on your own ability and willingness to absorb high losses, which in turn may be determined by your current income, age and financial goals.
The Importance of Diversification in Investing
Regardless of your financial goals, it is highly advisable for all investors to diversify their assets. “Diversification” is essentially the concept of not risking everything on one endeavor. With this technique, you lessen risks by spreading your money across different types of investments, different companies and different industries. A diversified portfolio built with stocks, bonds and other types of investments has a greater change of yielding higher returns in addition to minimizing risk.
By Melanie Henson –