Before you invest, it’s important to understand the basics about different types of investments.
Understanding types of investments
Instructions: Click each type of investment to learn more about it.
A mutual fund is a professionally managed collection of money from a group of investors. Instead of deciding for yourself what stocks or bonds to buy, a mutual fund manager makes these decisions for everyone in the group — deciding what to buy or sell, and when. Some mutual funds will be higher risk than others, and no mutual fund is a sure thing.
Because a mutual fund invests in a variety of stocks, bonds, and/or other products, there is usually greater potential reward than many low-risk investments, and usually less risk than buying individual assets.
Investing in stocks is risky because their value can change from day to day. But, stocks can also have great potential for growth and total return. When you invest in stocks, you’re investing in businesses. These could be small, medium, or large companies in the U.S. or around the world. Buying stock gives you part ownership in a company.
When investing in stocks, make sure your portfolio is diversified across different market sectors, industries, and geographies (countries). The fewer stocks you own, the more potential risk you are taking. For that reason, many investors prefer to invest in the stock market through mutual funds.
Stocks are usually bought and sold in units called shares. A share’s value, or share price, rises and falls based on how much people will pay for a share. People will pay money for the stock if they think the company will be successful. If it is, its stock will increase in value. Sometimes the company will also pay its investors a dividend. That’s when the company pays the shareholders a part of its profits.
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Corporations, governments and municipalities issue bonds to raise funds. In return they typically repay the bond owners with interest. In this way, a bond is like a loan. When you purchase a bond, you are lending money to a corporation or to the government for a certain period of time called a term. The bond certificate is a promise from the corporation or government that they will repay you on a specific date, usually with a fixed rate of interest.
Bonds are considered “fixed income investments” in that most pay periodic interest and principal at maturity. Bonds may provide a regular income stream or diversify a portfolio.
Interest rates are the most important factor affecting a bond’s value. When interest rates fall, the value of existing bonds rises because their fixed interest rates are more attractive in the market. When interest rates rise, the value of existing bonds drops because their fixed interest rates are less attractive in the market.
Yes, like all investments, bonds involve risk. Government bonds are at a lower risk of default, because they are backed by the U.S. government. However, their values can fall and rise based on the direction of interest rates, and if you sell them before they mature, you may potentially lose a portion of your initial investment.
Corporate bonds have a higher potential risk that the company may default on the loan. Like government bonds, if you sell the bond before it matures, the price you get will be determined by market interest rates and how long it is before the bond matures. You should research the company before you invest to make sure it has the ability to repay the loan. As with stocks, you also may want to consider using mutual funds for diversification when investing in fixed income.
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Many people invest in real estate, such as property or real estate investment trusts (REITs). One positive aspect to investing in real estate is that it has the potential to increase in value over time. Like stocks, you earn money when you sell real estate for more than what you paid for it. Keep in mind that it can take time to sell a property, and that there are costs involved in buying, selling, and owning real estate.
REITs, in contrast, trade on the financial markets. You can buy a REIT in the same way you could buy a stock. There are many different types of REITs and they offer exposure to types of property investment such as apartments and shopping malls. As with all investments, REITs can be risky — do your homework if you are considering adding them to your portfolio.
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