Sometimes they’re called assets, products, or vehicles, but they
all amount to all of the different ways for you to invest your
money. Because investing is an inherently uncertain endeavor,
understanding this and your tolerance for it is key in creating
a workable investment plan. If you take on too much risk, you
might panic and sell at the wrong time. Alternately, you could
play it too cool and miss out on big gains in the market. Here
are some asset classes listed from lowest to highest perceived
risk:
Cash
Cash is the paper currency tucked in your pocket as well as the
virtual funds in your checking and savings accounts. Cash is
considered to be very low risk. The money you park in a bank
account is protected by the FDIC for up to $250,000 and if
anything happens, you will not be at a loss for those funds.
Because cash investments are so low risk they are in turn very
low reward. The average savings account interest rate hovers at
under 1%, which isn’t even enough to overcome inflation.
However, many people are happy to give up the growth in exchange
for access and security.
Cash investments are best for people who want super low risk and
constant access. Whether it’s in your bank or under your
mattress, you can generally rest assured that your cash is safe,
but not giving much of a return, if any.
Bonds
Bonds, sometimes called fixed income, are a way for the average
investor to buy into debt. When you buy a bond you are loaning a
corporation or the government money in order for them to pay off
their debts or complete a project. In exchange, they will repay
you over time with very meager returns. The returns are so slim
because the bonds most certainly will be paid back, which makes
them a very low-risk investment option.
There are three types of bonds: Treasuries, corporate, and
municipal. Treasuries are backed by the full faith and credit of
our U.S. government and there is little risk of default.
Corporate bonds often carry a higher risk but generally offer
higher potential yields. Municipal bonds sometimes offer higher
rates but come with a bit higher risk because local governments
can go bankrupt, though it doesn’t happen often.
Bonds can be purchased through a traditional brokerage or even
directly through the U.S. government. Bonds are great for people
who are near to their retirement age and want to even out their
riskier investments with something more sound and predictable.
Mutual funds
A mutual fund is a bundle of stocks, bonds, or other assets—so
the risk associated is based specifically on what is in each
individual fund and how well it’s balanced. There are specialty
mutual funds that contain riskier investments, like emerging
markets, to try and capture a higher return. As expected, these
kinds of funds also tend to have a greater risk. Mutual funds
are actively managed, meaning a fund manager makes decisions
about how to allocate assets in the fund.
Mutual funds can be purchased directly from a mutual fund
company, a bank, an online platform, or a brokerage firm.
Investors who will access their money in more than five years
time are the best candidates for mutual funds.
Index funds
Even if you don’t know much about investing,
the name S&P 500 probably rings a bell—it’s an index fund.
An index fund measures the performance of a collection of
securities, which is meant to represent a sector of a stock
market. Some index funds track only companies of a certain size,
while others stick to a certain sector. Like a mutual fund, its
contents predict its risk level.
Index funds follow a passive investing path and generally are
best for long term investors. You can invest in an index fund
directly or through any number of platforms or a brokerage firm.
Index funds are best for investors looking to round out their
portfolios with a generally low fee fund that tracks overall
market performance.
Electronically traded funds, ETFs
In the simplest terms, an ETF is a collection of securities that
you can buy or sell through a brokerage firm on a stock
exchange. A bunch of stocks are bundled together based on some
underlying connection—say industry, performance, theme, or
geography for example—and then assigned a ticker number and
traded like a stock.
These function a lot like a mutual or index fund and, again, are
only as risky as their selections. Because the minimum ETF
buy-in tends to be lower than mutual funds, these can be a great
option for new investors.
Stocks
Over time, investments in stocks have given
the highest average rate of return. Because there are no
guarantees of high returns when you buy stocks, that makes them
a strong risk. Historically and on average, the stock market has
provided a 10% return to its investors who are well diversified.
Investing in stocks means to buy a small piece of a company in
exchange for a portion of its growth when it (hopefully) does
well. Stocks can be purchased from a bank, an online platform,
or a brokerage firm. Investing in stocks is a solid option for
investors who think they can turn a quick buck day trading and
those with a long way to go before they plan to access their
cash.
Alternative investment options
If an investment doesn’t fit into the
cash/stocks/bonds category, it is considered to be an
alternative investment. That can mean lots of things:
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Issuing personal loans and collecting interest with peer to
peer lending is a newish investment concept borne of a lock of
personal loans offered by banks.
-
Real estate, either in the traditional form or through
something called an REIT that trades value like a stock, has
always been an option but is now just becoming possible for
the average investor.
-
Art and collectibles have long been an interest for the
mega-wealthy, but now new-age platforms like Rally Road and
Otis allow investors to chip in on a piece together and share
the profits when sold.
While these outside the box investments might seem like the
riskier option, they’ve historically pulled the same average
return as the stock market. Alternative investments can be a
great element of an already diversified portfolio for an
adventurous investor.