Investing for Beginners: The Most Common Types of Investments &…
Amilcar Riera
Much like embarking on an adventure, navigating the business landscape requires meticulous planning, the right tools, and a knowledgeable guide. Nevertheless, just as a sudden storm disrupts a journey, unexpected market changes can disturb the tranquillity of commerce.
Yet with resilience and adaptability, both the explorer and the entrepreneur are able to turn these hurdles into opportunities for growth, learning, and, of course, wealth.
Today, we set forth on a daring expedition, not through the wilds of an unexplored jungle but rather along the bustling, neon-lit streets of the investment world. In such a setting, risk and reward are the driving forces, and fortunes may shift in the blink of an eye.
But don’t fret. We can come alive victorious. Let’s navigate this terrain together, shall we?
A Double-Edged Sword
Whether it’s stashing away funds for a gold retirement, the dream of an Ivy League education, or the keys to a luxurious abode, investing is the vehicle that promises to get you there.
However, akin to sailing the high seas, betting on the market comes with violent waves and a few sea monsters.
Risk, the ever-present shadow of reward, lurks in the waters, embodying the chance that the treasure chest might be lighter than when you started, or worse, completely vanish.
The Investment Landscape
At its heart, investing is comparable with planting and nurturing a seed with the hope it will grow into a towering tree, bearing fruits of wealth and prosperity.
Venturing into the investment universe, we meet a plethora of opportunities, each with its own character and tales of fortune and folly.
In the upcoming chapters of our financial expedition, we delve into the diverse landscape of the most common investments, showing how each sculpts the contours of your portfolio with their distinct advantages and inherent risks.
Stocks: The Wild Stallions
Stocks, also known as shares or equities, might be the most famous and simple form of investment. They sway to the rhythms of market sentiment, economic trends, and corporate performance, making them exhilarating yet unpredictable partners in your financial journey.
With a stock, you’re acquiring an ownership stake in a publicly traded company and riding the waves of its success and downturns.
Many major companies, including Apple, Exxon, and Microsoft, are listed on the stock exchange. This means you can buy shares in these corporate giants.
How to Make Money from Stocks?
When purchasing a stock, you hope that its price will go up, allowing you to sell it for a profit. Of course, there’s a risk: the value could plummet, resulting in losses.
Pros of Investing in Stocks
1- Grow with Economy
A strong economy boosts corporate profits. This leads to more jobs, higher incomes, and increased spending—all beneficial for companies.
2- Stay Ahead of Inflation
Throughout history, over the long term, stocks have yielded a generous annualised return, better than the average annual inflation rate.
3- Easy to Buy
The stock market makes it effortless to purchase the equities of businesses through brokers, financial planners, or online.
4- Low Barrier to Entry
You don’t need substantial capital to start investing. Most retail agents offer commission-free trading and have no account minimum requirements.
5- Income from Price Appreciation and Dividends
Many equity holders intend to buy low and sell high. They invest in fast-growing companies that appreciate in value.
6- Liquidity
Stocks are, in general, simple to transact, providing investors with flexibility.
1- Risk
Stock prices can rise and fall dramatically, so there is no guaranteed revenue.
2- Stockholders of Broke Corporations Get Paid Last
If a firm does poorly, stockholders often find themselves at the end of the line when it comes to receiving payments. In such cases, losses occur.
3- Taxes on Profitable Sales
When selling a stock for a profit, you’re liable to pay for your gains.
4- Emotional Ups and Downs
The volatility of the market may take a toll on your emotions.
5- Vying with Institutional and Professional Investors
Individuals are often competing against players who have access to extensive resources and data.
NOTE: Remember that allocating capital in stocks should align with your financial goals, risk tolerance, and investment horizon. Seeking advice from a professional is always a prudent step before making decisions.
Bonds: The Steady Steeds
Unlike stocks, bonds are considered to offer a guaranteed return, giving a more measured pace through the investment landscape.
When you buy a bond, you’re lending money to an entity – be it a business or a government.
Companies issue corporate bonds, whereas countries offer treasury bonds, notes, and bills, all of which are debt instruments that investors get.
How Do Bonds Generate Income for Investors?
While you lend your money, you receive regular interest payments. Once the bond matures (reaches the end of its term), you get your principal back.
The rate of return for bonds is by and large lower than for stocks, but bonds also tend to be less risky.
Even though they involve risks, such as the company or the government defaulting, bonds are considered safe investments.
Pros of Investing in Bonds
1- Reduced Risk
Bonds backed by issuers that are able to repay debts are safer compared with other assets.
2- Portfolio Diversification
Bonds provide steady income and help balance a portfolio against riskier assets like stocks.
3- Predictable Revenue
Interest from bonds could be a steady financial lifeline since investors know from the beginning how much they will earn.
4- Tax Exemption
Certain bonds are tax free, such as those at the federal level.
5- Attractive Interest Rates Compared to a Bank
Bond dividends are higher than those received in savings and checking accounts at financial institutions.
Cons of Investing in Bonds
1- Interest Rate Risk
If interest rates go up, investors who hold bonds with fixed percentages may end up with a lower return on their investment.
2- Default Risks
You need to be aware if the issuer cannot pay.
3- Limited Growth Potential
By contrast with stocks, bonds have an upper limit, as the interest rate is predetermined.
4- Prices Fall if Rates Increase
Bond prices and interest rates move in opposite directions, so when prevailing interest rates rise, bond prices plummet.
Cash Equivalents: The Safe Harbours
These are the calm waters amidst the tumultuous ocean of investments. These financial instruments, such as money market funds and treasury bills, promise safety and liquidity, albeit with modest returns.
Through these instruments, investors seek shelter from storms. However, they run the risk of falling behind the inflationary tide and seeing their savings lose purchasing power.
A mutual fund is a collective pool of many investors’ money that is placed across several companies. Let’s explore the nuances:
Actively Managed Funds
These funds have a manager who picks securities in which to put the participants’ cash. The goal? To outperform a designated index by selecting investments that surpass its performance.
Passively Managed Funds (Index Funds)
These track major market indexes, such as the Dow Jones Industrial Average or the S&P 500. They invest across a wide spectrum of securities, including equities, bonds, commodities, currencies, and derivatives.
Risk and Diversification
While mutual funds carry some of the same risks associated with stocks and bonds, depending on their underlying investments, they are inherently diversified, which helps mitigate risks.
How to Make Money From Mutual Funds
When the value of the securities, such as stocks, bonds, and other assets, held by the mutual fund increases, the fund’s net asset value (NAV) rises. As an investor, you benefit from this capital appreciation.
Mutual funds often invest in income-generating assets, including dividend-paying stocks or interest-bearing bonds. The earnings are distributed to investors periodically.
When the fund manager sells securities within the portfolio at a profit, the resulting capital gains are given to shareholders.
Many mutual funds offer the option to reinvest dividends and capital gains back into the fund. By doing so, you buy additional shares, compounding your investment over time.
NOTE: Mutual funds can be bought directly through a managing firm or brokers, but there’s on average a minimum investment and you’ll pay an annual fee.
Exchange-Traded Funds (ETFs)
ETFs share similarities with mutual funds, but they operate with a few key differences:
Like mutual funds, ETFs are a collection of investments that track a market index. However, their shares are traded in stock markets.
Unlike mutual funds, which calculate their valuation based on the net asset value (NAV) of your investments at the close of each trading session, ETFs’ worth fluctuates throughout the day. Their prices change as investors buy and sell shares in real time.
How to Benefit From ETFs?
You profit from ETFs by selling them when their prices increase. As the underlying index or assets perform well, your shares appreciate.
Certificate of Deposit
A Certificate of Deposit (CD) is an instrument where you deposit money with a bank for a specific period of time. In return, the bank pays you interest on that cash.
Once the agreed-upon time frame elapses, you receive your initial investment (the principal) along with the predetermined interest. While the risk is very low, so is the potential return.
How to Make Money From Certificates of Deposit?
Well, from the interest you earn during the period of the deposit. CDs are good long-term investments for saving money. There are no major risks because, in the US, they are FDIC-insured up to $250,000, which would cover your money if the bank were to collapse.
That said, be sure you won’t need your cash throughout the CD, since penalties for early withdrawals may apply.
Strategy: CD Laddering
Laddering a Certificate of Deposit is a savvy approach for investors seeking to enhance both liquidity and yield. Here’s how it works:
Instead of locking all your funds into one long-term CD, distribute the resources among several CDs with staggered maturity dates (e.g., one, two, three, four, and five years).
As each certificate matures annually, you have the option to access a part of the capital without penalty, offering a measure of liquidity that a single certificate does not offer.
Moreover, when a CD yields returns, consider reinvesting the proceeds into a new one. If interest rates have risen, you’ll benefit from a potentially higher rate.
Retirement Plan
A retirement plan serves as an investment account with certain tax benefits, designed for your post-work years.
The most typical are those that your employer sponsors, such as 401(k) and 403(b). If you don’t have access to any of these, go for an individual retirement plan (IRA) or a Roth IRA.
How to Grow Your Retirement Plan?
They aren’t a separate category of investment per se but a vehicle to buy stocks, bonds, and funds in two tax-advantaged ways. The first lets you invest pretax dollars, and the second allows to withdraw cash without paying taxes on that money.
This financial phenomenon occurs when the interest earnings on your savings generate their own interest, in turn, creating a snowball effect. Over the span of decades, this action can transform modest contributions into a substantial nest egg.
This illustrates the adage that, when it comes to building wealth for retirement, time is indeed more valuable than money.
Alternative Investments
Beyond the familiar paths lie the realms of real estate, commodities, hedge funds, and the enigmatic cryptos.
These lands are rich with the promise of untold fortune and riches but are fraught with perils: opaque markets, illiquidity, and the ubiquitous spectres of regulatory and operational risks.
Today, let’s focus on real estate.
Real Estate Investment Trust (REIT)
This is a unique investment vehicle that allows individuals to participate in real estate without directly owning properties. Here’s how it works:
REITs own and/or manage income-producing commercial, residential, medical, or industrial real estate.
They may hold the actual properties themselves or the mortgages associated with them.
Structured by licensed companies, REITs distribute at least 90% of their taxable revenue to shareholders.
REITs offer diversification, allowing you to add real estate exposure to your portfolio.
Their ability to generate dividends along with potential capital appreciation makes them an excellent counterbalance to traditional investments like stocks, bonds, and cash.
Historical Performance
Over the years, real estate investment trusts have been one of the best-performing asset classes.
The FTSE NAREIT Equity REIT Index serves as a benchmark for the US land and building market. As of June 2022, the index’s 10-year average annual benefit was 8.34%.
Over a 25-year period, the index returned 9.05%, compared with 7.97% for the S&P 500. This data suggests that investors seeking yield have fared better by investing in real estate than in fixed income.
You find different REITs based on the properties on which they’re focused. These are the most common:
1- Retail REITs
Around 24% of REIT investments are in malls. Whatever shopping centre you visit, chances are it’s owned by a REIT.
When considering an investment in this field, examine the current profitability and what the outlook is for the future.
Retail REITs profit from the rent charged to tenants. If retailers are experiencing cash flow problems due to poor sales, they could delay or even default on those monthly payments. At that point, a new tenant needs to be found—not an easy task, though.
In a bleak economy, retail REITs with significant resources will have opportunities to buy valuable real estate at distressed prices. The best-run companies take advantage of this.
2- Residential REITs
These own and operate multi-family rental apartment buildings as well as manufactured housing. Before jumping in, consider this information.
The cream of the crop tends to be where home affordability is low. For instance, in New York and Los Angeles, the high cost of single homes forces more people to rent, driving up the price landlords charge each month. As a result, the largest residential REITs focus on large urban centres.
Another factor to consider is population and job growth. When a fresh inflow of workers comes to a city, it’s because jobs are readily available and the economy is expanding. A falling vacancy rate coupled with rising rents is a sign that demand is improving.
As long as supply remains low and appetite continues to rise, residential REITs should do well.
3- Healthcare REITs
This is an interesting sector to watch as medical expenses soar to new heights. These types of REITs invest in hospitals, healing centres, nursing facilities, and retirement homes.
Most of the operators of these assets rely on occupancy. So, an increase in the demand for services, which should happen with an ageing population, is good for this area.
4- Office REITs
They receive rental income from tenants who have signed long-term leases in office buildings.
Keep this in mind when investing in this field. It is better to own a bunch of standard buildings in Washington, DC, than a prime space in Detroit.
Location, location, location.
5- Mortgage REITs
They are government-sponsored enterprises that buy mortgages on the secondary market. Even though this type invests in credits on property instead of equity, that doesn’t mean it comes without risks.
Mortgage REITs get a good deal of their capital through secured and unsecured debt offerings. So, if interest rates rise, future financing will be more expensive, reducing the value of a portfolio of loans.
The biggest benefit is their high-yield dividends. Often, these dividends exceed those of the average stock on the S&P 500.
Another positive aspect is diversification. Not too many people have the force to go out and buy a piece of commercial real estate to generate passive income. But REITs give the public the capability to do exactly that.
Disadvantages of REIT Investing
REIT dividends do not meet the IRS definition of qualified dividends, so the above-average benefits are taxed at a higher rate than most earnings. While companies offer the reinvestment of the returns, the investor can’t avoid the tax obligations.
Another potential issue is REITs’s sensitivity to interest rates. When the Federal Reserve raises interest rates to tighten up spending, as it’s happening now, REIT prices fall.
Furthermore, specific types of real estate investment trusts, such as hotel REITs, often do poorly during times of economic downfall.
Charting Your Course
Embarking on an investment journey is to accept the invitation to a grand ball, where the music of the markets never ceases and the dance of risk and reward is eternal.
It demands a keen eye, a steady hand, and an unflappable heart. Thus, define your time horizons, appetite for adventure, and your dreams of treasure.
Remember, the universe of investing is not for the faint-hearted but for the brave, the patient, and the wise. In this world, the most significant risk is not venturing at all, letting the seeds of wealth wither in the safety of the shore.
So, dear investor, with eyes wide open and hearts steeled, it’s time to step forth into the arena. But keep in mind that every explorer needs a compass, and in the realm of investing, it is knowledge and advice from those who have navigated these waters before. Don’t set sail without it.
Dare to dream, but also dare to learn. Start by setting up a meeting with a financial adviser, enrolling in an investment course, or joining a community of fellow investors.
The path to wealth is a journey of a thousand miles that begins with a single step. Make that step today.
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Posted Dec 17, 2024
Navigate the financial landscape with confidence with this short guide to the most common types of investments, from stocks to REITs
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