How is it that most of the world’s richest individuals accumulated their wealth through investing and not from active (earned) income?
The simple answer is that the effects of inflation erode the value of money year-over-year, so investing is an absolute must. Plus, a person is limited by their time, while investments can be infinitely stacked and work for you while you sleep.
Are you ready to start your investing journey? Keep reading to learn about 15 common types of investments and how they work.
1. Bank Fixed Deposits
By one estimate, almost half of Americans don’t have any investments at all. And that’s understandable. Getting involved can seem daunting for a beginner. However, if you have a bank account, you already have a great beginner’s tool at hand.
Fixed deposits are a contract between yourself and a bank for you to place a deposit with them for an agreed-upon length of time. At the end of the contract, you get your deposit back plus a pre-determined percent in interest.
Since the deposit is backed by your bank, it is one of the safest investments that you can make. The trade-off is that you can expect a minimal return on your investment, usually only 0.5% to 1% (and sometimes less).
That’s why seasoned investors will tend to use fixed deposits as a place to hold their money while seeking out more lucrative opportunities.
2. Certificate of Deposit
A certificate of deposit, called a CD for short, is nearly identical to a fixed deposit.
With this investment, the investor buys a CD, which is an agreement to leave a certain amount of money on deposit with the bank for an agreed upon period of time—commonly 6 months, 1 years, or 5 years.
In exchange, the bank pays the investor a small interest rate and guarantees the repayment of their original deposit at the end of the term. Naturally, the interest rate paid to the investor is lower for shorter time periods and slightly higher for longer time periods.
One small difference between a fixed deposit and a CD is that CDs which are bought through a brokerage (called “Brokered CDs”) can be re-traded to another person. Because these CDs can be sold on the secondary market, there is the possibility to convert them to cash if you need it.
In contrast, bank issued CDs usually hit you with large withdrawal penalties if you want to cash them out early.
Bonds function a lot like certificates of deposit. When a business needs to raise funds for something like a major expansion, it might choose to solicit the public for what amounts to a loan.
They do this by selling certificates called bonds, which are basically a documentation of shares and a promise to repay those shares at a later date, plus an agreed-upon rate of interest.
It’s important to know that there are different “grades” of bonds. High-grade bonds issued by major, reliable businesses, are safer investments because you can better count on them to repay the loan.
Lower-grade bonds issued by smaller businesses with less-established track records are riskier, because these business are less able to guarantee repayment.
Stocks are fractional shares of a company, so when you buy them you own pieces of that company.
While stocks can fluctuate dramatically in price over the short-term, over the past 100 years, the stock market at large has produced an estimated return of approximately 10%.
You can either buy individual stocks or you can buy an index fund, which is a portfolio of stocks designed to track the performance of a particular market segment.
An exchange traded fund (ETF) is a type of investment fund that is traded on a stock exchange. These investment funds can hold assets such as stocks, bonds, currencies, commodities, or precious metals.
Several shareholders own the ETF and each can buy or sell their shares on the stock market. ETFs are tax-efficient and they have fewer management fees than mutual funds.
6. Mutual Funds
Mutual funds are professionally managed funds that collect money from many people for investment across different securities. With mutual funds, professional fund managers pick the stocks to invest in and then sell shares of that fund to the public.
By owning a stake in the fund, you get the benefits of a diversified stock portfolio at a low price of entry, without having to personally manage it.
The trade-off is that the fund managers charge hefty fees for their services, usually in the form of an upfront administration fee and an annual maintenance fee. This can reduce your total return from the investment and make it less profitable.
7. Index Funds
Index funds are an investment fund similar to mutual funds or ETFs. The main feature that differentiates an index fund is that it is composed of stocks found in a financial market index, such as the Standard & Poor’s 500 Index (S&P 500).
Therefore, the fund performs similarly to the financial market index.
Index funds have low investment fees as compared to mutual funds, because they don’t need active management.
Speaking of real estate, REITs are another way to enter the property market. REIT stands for Real Estate Investment Trust.
They are funds that work a lot like mutual funds but for properties. The fund solicits investments from the public and uses that money to acquire property. That makes you a part-owner of the fund’s properties and entitled to a share of the profits generated by them.
However, with this investment approach, you own a paper asset (shares of the REIT) instead of a hard asset (the physical real estate itself).
Annuities are an agreement between you and an insurance company. It says that if you invest a certain amount with them, they will pay you an agreed upon monthly income in the future.
This can be a powerful way to get a guaranteed income upon retirement that can last you until you die.
If you worry about economic uncertainty and inflation, then gold might be an interesting investment for you.
You can buy physical gold coins or bullions and store them in a safe at a financial institution or at home.
Some people prefer to buy exchange-traded funds (ETFs) that are linked to and track gold, because these are easier to buy and sell. The downside of this approach is that you would own a paper asset (shares of the ETF), instead of the physical gold itself.
11. Rental Real Estate
Real estate refers to immovable property such as land and the resources on it such as buildings, crops, minerals, oil, or water. People who invest in rental real estate purchase properties with the aim to rent either the land or the structures on them to tenants at a profit.
Examples of this type of investment include but are not limited to are residential properties (houses, townhouses, condos), multi-family properties (apartments), mobile home communities, and AirBnB rentals.
In some cases, people engage in buying and flipping properties or wholesaling real estate, but these types of real estate investments can take up a large amount of your time.
The world’s richest people frequently invest in real estate, because land and buildings are tangible assets and a great way to diversify one’s portfolio.
12. Peer-to-Peer Lending
Another great way to earn interest on spare cash that you have is to invest in peer-to-peer lending.
Peer-to-peer lending involves the act of lending money to other people or businesses in exchange for receiving interest on your money. Basically, you act as a bank and give out a loan on which you get paid back your original amount, plus interest by the borrower.
The benefit of this type of investing is that it can generate consistent cash flow and often produces a strong rate of return.
Cryptocurrency is a form of digital currency that is difficult to duplicate or forge. This is because it is produced using cryptography and blockchain technology, which is a disparate network of computers.
Because of their limited supply, cryptocurrencies have the potential for price appreciation and can act as a powerful hedge against inflation.
Crypto investors like that cryptocurrencies can’t be controlled by any government. But, their exchange rate can be volatile and the infrastructure used to produce them is still under development.
14. Mortgage Tax Liens
An investment that has gained a lot of interest recently is property tax liens. Property owners have to pay annual taxes on their property. Some property owners neglect to do so either due to lack of funds or ignorance.
In order to earn some money, municipalities frequently conduct auctions whereby they sell off these debts to the highest bidder.
The owner of the lien can then contact the property owner for payment of the tax lien.
15. Private Placements
A private placement is a sale of stocks or bonds to a group of prequalified investors. When a company needs to raise funds for its operations it can opt to avoid doing a public IPO (initial public offering).
Instead, it can approach a select group of investors for capital in the form of a private placement.
Private placements don’t have the same regulatory requirements as IPOs, so you’ll want to do your due diligence before piling on board.
Comparing Different Type of Investments
Investment knowledge is a critical life skill that is not taught to us within the school system. Thankfully, anyone can become a successful investor by learning about different types of investments and taking action to get in the game.
The different investment types mentioned here are all effective ways to get started. So, choose the ones that appeal to you based on their relative risk and return and get started on your journey toward financial freedom.