An investment can be anything from a piece of land, to a stake in a small business, to stock in a Fortune 500 company. If you put money into something expecting a financial return, you’ve made an investment.
For practical purposes, you can break investing down into a handful of categories: stocks, bonds, real estate, and exchange traded funds. Here’s what you should know about each category, as well as a breakdown of the newest investing approach: automated investing.
Stocks
You’ve probably heard of stocks, the most well-known investment type. A share of stock represents ownership in a corporation. If you buy Nike stock, for example, you own a part of Nike. Only publicly traded companies have stocks, and public company employees sometimes receive stocks as part of their benefits package.
Individual stocks sometimes pay dividends, a way of distributing profits to shareholders. Dividend-paying stocks are popular because they provide a source of passive income.
>> Learn More: How to Invest in Stocks - A Simple Guide
Investing too heavily in stocks can be risky, because they represent just one company. If you have $5,000 worth of Google shares and another dot-com bust hits, your shares would be worthless. If most of your retirement account is made up of stocks, your portfolio isn’t properly diversified.
Fans of stock investing will point to companies like Facebook as examples of why investing in stocks can be extremely profitable. Facebook went public in 2014 with a share price of $38. In 2019, each share is worth $177. If you invested in Facebook when it debuted and sold your shares now, you’d have a return of 365% in less than five years, crushing the average annual S&P 500 return of 10%.
But not every company has those kinds of returns—not even close. So it’s important to build a diversified portfolio, insulating yourself from the volatility of a single company’s stock.
Bonds
Bonds are the more conservative sibling to stocks. A bond is like a small loan made by the bondholder to the company or government entity selling the bond.
Companies or governments issue bonds to raise money, usually as part of an expansion strategy or for a specific project. During World War II, the US government issued war bonds to help pay for defense expenses.
Bonds may be packaged into bond funds, which are often a mix of both government and corporate bonds. You can buy domestic or international bonds from brokerage firms or buy individual bonds directly from companies or governments.
Bonds come with a set interest rate. The interest rate is usually less than what you’d earn with an index fund. According to Morningstar, the average interest rate of a bond is between 5-6%.
Investors buy bonds and bond funds to offset the risks of investing primarily in stocks and stock funds. A mix of bonds and stocks is necessary for a diverse portfolio. Bonds provide some measure of stability because you always know what kind of interest rate you’re earning.
A young investor needs to be more aggressive in their investments, and so should hold a small percentage of their portfolio in bonds. A retiree, on the other hand, should own more bonds than stocks.
Real Estate
Investing in real estate can happen a few different ways, from buying real estate directly to investing in it through the stock market.Becoming a landlord is one way of investing in real estate. Landlords earn a return on investment by charging more in rent than their mortgage, property taxes and other expenses. Eventually the mortgage is paid off and the landlord earns an even bigger profit margin. The downside to being an owner is that it comes with chasing down late rent payments, dealing with maintenance and finding new tenants—or highering someone to do that for you.
Real estate is considered a passive form of investing, but it can be a huge headache and time suck if you end up renting to the wrong people. One negligent tenant can undermine years of hard work in just a few months.
Another type of real estate investing is “flipping” properties. Flipping means buying a run-down or outdated home and renovating it, either by doing the work yourself or hiring contractors. Once the work is finished, the flipper sells the house for a profit.
Flipping a home can also be risky, especially if you’re not experienced with home repair. A market slowdown, bad contractors or surprise problems can negate your profit or wipe it out completely.
The Real Estate Investment Trust (REIT) is a way to invest in real estate without physically buying and owning a property. Some REITS buy malls, office buildings or apartments. When you buy a REIT share, you usually become an owner in several different kinds of properties. If there’s a recession that affects the residential or commercial housing market, could also affect REITS.
Exchange-Traded Funds
Exchange-traded funds are like mutual funds, representing a group of corporations bundled together in one fund. The main difference between ETFs and mutual funds is that you can trade an ETF like a stock. You can sell a share of your ETF anytime the market is open, whereas mutual funds can only be sold during a specific time of day.
ETFs come in both active and passive varieties, such as index funds that track the S&P 500. Passively-managed ETFs almost always have lower fees than active ones. They’re usually inexpensive and have no minimum investment requirement like some mutual funds do.
Here’s an example of how an ETF works: The popular Vanguard Total Stock Market Index Fund, for example, has a $3,000 minimum investment. If an investor wanted to buy shares of that fund, they would have to buy at least $3,000 worth. If they can’t or don’t want to buy that many shares, they can buy the ETF version of the fund. Both have the same expense ratio of 0.04%.
You can buy ETFs in your Roth or traditional IRA and your 401(k) if your company includes those options. The potential downside to investing with ETFs might sound like an upside: They’re very easy to trade. Every time you sell or buy an ETF, you pay a commission fee. Those fees can add up quickly if you buy and sell ETFs frequently. The best strategy is to only purchase ETFs you want to keep for the long-term.
Automated Investing
Automated investing is becoming more commonplace as robo-advisors target people who want to invest, but are overwhelmed by the process.
Robo advisors rely on a proven algorithm to invest in funds for the average person. They use formulas to pick low-cost ETFs and other funds that will provide market-level returns without high fees.
A robo-advisor decides which funds to invest based on your personal profile, desired retirement age, and risk comfort level. The robo-advisor will often explain how much to save, and most will allow you to make automatic contributions to your retirement account.
Robo advisors will rebalance your portfolio, diversify your investments and reinvest any dividends for an affordable price. Wealthsimple Invest charges a .5% fee for accounts between $0 and $100,000 and .4% for accounts worth more than $100,000. There’s also no minimum amount required to open and maintain an account.
You can open a traditional IRA, Roth IRA or SEP IRA with a robo-advisor. Some robo-advisors will sync all of your retirement accounts, including your 401(k), to monitor your saving progress and give notice when you’re falling behind.
Automated investing is a great way for beginners to start a portfolio, because you don’t have to learn which funds are most appropriate or how to properly diversify. Financial planners tend to require a certain amount of assets or a large one-time fee to analyze your portfolio and make recommendations, so robo-advisors are the only advisory option for someone in a lower income bracket.
How to Choose the Right Investment
Picking the right investment strategy is about determining your risk tolerance and personal goals. Those with a low tolerance for risk or a fast-approaching retirement date might want to consider sticking to bonds and bond funds, where the returns and risk are both low.
An investor with a stronger appetite for risk could invest in low-cost ETFs, particularly index funds. These funds are supported by well-known investors like Warren Buffett and John C. Bogle. Those who are very comfortable with risk—and can afford to take heavy losses in the event of a market downturn—should look into stocks or real estate investing.
In a perfect world, every investor saving for retirement and other long-term goals would have a mix of both aggressive and conservative investments. If you’re still not sure what kind of investment is right for you, consider automated investing with a robo-advisor. A robo-advisor takes guesswork out of the equation by looking at your personal preferences and suggesting the best mix of funds.
