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    Understanding The Three Types Of Investment Options

    Investing your money can seem pretty overwhelming. But by understanding the pros and cons of ownership, lending, and cash investments, you can build a diverse portfolio that fits your comfort level. 
    Updated: August 3, 2017

    What You'll Learn

    • What the three types of investments are.
    • Which options offer less risk, and which provide better returns.
    • Why having a diverse portfolio matters.
    Two women looking at documents

    Saving money is an important part of a healthy budget. Financial advisers suggest putting at least 10% of your take-home pay toward savings. But where should you actually put that money to help ensure the best returns for you?

    It’s always smart to start with an emergency fund. If you’ve already funded this and are focusing on longer term goals (like buying a home, retiring, paying for your child’s education, etc.), you’ll likely want to invest your money.

    Investments are assets that you expect to increase in value over time. You can invest money in many different ways—so many, that the options can seem overwhelming. However, at a high level, they all fall into three main categories: ownership investments, lending investments, and cash investments.

    Ownership Investments

    Ownership investments are items you buy hoping they’ll gain value over time. The longer you own them, the better off you usually are. These investments tend of offer the greatest profit—but also the greatest risk. Whether they make money or not depends on unpredictable external factors.

    These investments include purchases like real estate and precious metals, but not all valuable things you own. For instance, a car traditionally loses value the second it leaves the sales lot and a new laptop becomes less valuable as soon as you open the box.

    Here are some other examples of ownership investments that can become worth more the longer you own them:

    Stocks

    With a stock, you literally buy a piece of a company. From Amazon to Zillow, you can buy shares of some 2,800 public companies on the New York Stock Exchange.

    You can make money from stocks a couple ways. First, if the company succeeds, you will likely be able to sell your shares for a higher price than you paid for them. Second, many companies reward shareholders with scheduled cash payments known as “dividends.”

    It’s easy to lose money on stocks as well, though. While the stock market overall has steadily gained value over the past century, this isn’t the case for all individual companies. If the company you invest in loses money or goes bankrupt, you’ll likely take a loss, too.

    Funds

    Funds combine multiple investments into a single product—typically, anywhere from 100 to 3,000 holdings. Investing in a fund diversifies your money, which helps safeguard your finances against loses. For instance, if a stock within a fund loses value, it will hurt you less than owning just that stock—because other holdings in the fund will likely increase in value, balancing out the loss.

    Fund can include stocks, bonds, and other investments. Sometimes, these are related. For instance, a technology fund could include stock in Apple, Microsoft, and Facebook, among others. You can find out a fund’s specific investments in its prospectus.

    You can invest in a few different types of funds. The most common are mutual funds and exchange-traded funds (ETFs), though these have significant differences in terms of how they’re traded and what they cost. Lifecycle funds are another option. These are mutual funds tied to a specific investment goal or savings event, such as retirement. 

    Lending Investments

    With these investments, you lend an institution or entity your money. Typically, they offer fixed interest rates and tie up your money for a set period. If you pull your money out before that period ends, you’ll face penalties like forfeiting any earned interest.

    Lending investments offer a smaller return than ownership investments—but they come with less risk as well. They’re much more predictable. Examples of lending investments include:

    Bonds

    With a bond, you essentially loan money to a company, government, or other entity. In return for this money, you receive interest payments periodically plus your initial investment back after a set amount of time—also known as the bond’s maturation date.

    You can purchase bonds just like you’d purchase stocks. Also like stocks, bonds’ prices can rise and fall. However, unlike a stock, your bond’s value won’t change based on a company’s performance. Whether a company is successful or not, you won’t get more or less money for your bond.

    Certificates Of Deposit (CDs)

    With any interest-bearing credit union or bank account, you more or less act as your financial institution’s lender, letting them hold and use your money in return for receiving interest on it. With a regular savings account, that interest is minimal—typically a fraction of a percent.

    CDs are a banking product with a better interest rate. But in exchange for it, you can’t touch any money deposited in a CD for a defined period without paying a penalty. This could be anywhere from a few months to a few years, with longer terms generally providing higher interest rates.

    Peer-To-Peer (P2P) Lending

    With P2P lending, you lend money to other individuals. Like other lending investments, you earn money off P2P loans via interest payments from the borrower. This rate of return is typically stronger than with bonds or CDs. However, unlike other lending investments, P2P investments carry some risk.

    Cash Investments

    Cash investments are investments that you can easily access in case you need the money. Your emergency fund should be in a cash investment, like a checking or savings account.

    Because interest rates are typically low on these accounts, you may want to use a high-yield online option for money you don’t need daily access to. These accounts don’t offer the real-time liquidity of a brick-and-mortar bank, and you may have to wait a couple days to get your money. However, they also won’t tie up your money as long as a lending investment does—even though their interest rates can be comparable.

    Finding Your Fit

    The types of investments you choose are a personal decision, and they often depend on how comfortable you are with risk. You may be more or less risk averse depending on where you are in your life or career—or based simply on your overall financial mindset.

    One thing you can do to reduce risk is spreading your money across different investment types and assets, i.e., diversification. That way, if one high-risk investment falters, you can wait it out because you’ll still have other investments making money—and cash to fall back on.   

    If you’re looking to build a diverse portfolio that matches your risk profile, robo-advisers and online services often offer plans that let you do this. But it also never hurts to talk to a financial planner in person. Check with your credit union or bank to see if they offer this service.

    Actualizado: 3 agosto 2017
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