— October 29, 2018
Investing is an important part of preparing for the future. If you want to retire someday, investments and other retirement savings are vital for success. But if you don’t know where to start, the entire world of investments can feel intimidating. Here is a list of 7 types of investments you should know about and how they may fit into your long-term financial plan.
Every investment has some level of risk, but the lowest risk investment is one with the United States government. Treasury Bills are the closest thing to “risk-free” investing you’ll find. But where there is little risk, you’ll also find little return.
Treasury Bills are ultra-low-risk investments that many investors buy through a mutual fund or ETF. Often called “T Bills” by experienced investors, annual yields range from around 2% to 3% as of this writing in October 2018.
Certificates of Deposit
The next level up on the risk-reward scale is a bank Certificate of Deposit, or CD. CDs are a time-bound deposit account available at most banks and credit unions. Like checking and savings accounts, CDs are insured by the FDIC up to $ 250,000 per depositor, so there is almost no risk with this investment, though calling it an “investment” rather than a “savings” product is easily debatable.
Many banks offer IRA CDs, which work as a tax-advantaged retirement account. However, the interest you’ll get from this type of account is very low compared to stocks and bonds, which should make up the majority of investor portfolio. Depending on the rate and the term, rates today at some banks start around 0.10% for a short-term CD.
The next step on the risk ladder is Government bonds. Government bonds are issued at the Federal, state, and municipal levels. Federal bonds are generally the safest type of government bond, as states and cities can run into financial problems and mismanagement that puts bond repayments in jeopardy.
Government bonds are commonly held in bond funds and target date retirement funds. While T Bills and CDs don’t offer much regarding interest, some government bonds do offer more compelling rates. But as they are backed by the “full faith and credit of the United States,” you don’t have to worry too much about losing your money with this low-risk investment.
A corporate bond is a loan to a big company that pays you back with interest. Most individual investors don’t buy bonds directly; they own them through mutual funds and ETFs. A corporate bond offers better interest rates than government bonds for the most part, but there is also a bit more risk. If a company goes bankrupt, for example, bondholders may not get paid back in full.
Bonds are rated on a risk scale by a few different rating agencies. The most common scale puts AAA rated bonds as the safest. Higher risk bonds are called junk bonds but still offer good returns in a well-diversified portfolio. Bonds pay an interest payment periodically over the life of the bond, known as a coupon, and the final principal is repaid at maturity.
Preferred stock works like a mix of a bond and what you think of as stock (that’s in the next section). With preferred stock, the holder gets a guaranteed payment each quarter like a bond, but there is no expiration date at the end. Preferred stockholders are paid out after bondholders but before common stockholders in the event of a bankruptcy liquidation.
One downside of preferred stock is that you don’t get a vote, as you do with common stock. That means while you have a relatively safe and secure position, you don’t have a say over the direction of the company’s future. In some cases, preferred stock is convertible to bonds or common stock.
Common stock is the most popular type of stock. You might even call it the most… common. (#DadJoke) But in all seriousness, stock is arguably the most popular and overall best investment for the average investor. A portfolio made up primarily of diverse common stocks tends to do very well over time. While stock is quite a bit more volatile than bonds and the investments above, over any extended period going back decades the S&P 500 returns around 10% annually.
Buying single stocks makes it difficult to get good diversity with a smaller portfolio, which is why mutual funds and ETFs are the best places for most people to invest. With one trade, you can buy an S&P 500 ETF that includes a small slice of 500 different stocks at once. For most investors, diverse index funds tend to do well over a long period.
Options & Futures
Options give the buyer an opportunity to buy a stock or other asset at a specific price on a specific date. Futures are like an option, but there is usually an agreement that you have to make the purchase at the future date. In either case, these are very risky activities, and most people should avoid them. If you want to learn more about investing here, you are best off to read an in-depth book on the subject.