You probably have things you want to do with your money down the road: buy a house, save for retirement, fund college for your kids, maybe even go on a trip or do a remodel. Are you wondering if investing can help you achieve those goals or where to start?
The good news is that it’s never too early or too late to start investing. There are a number of different ways you can put your money to work, even if finding a portfolio strategy can be daunting.
Before deciding on your investments, ask yourself what your financial goals are. Then try to build a portfolio that achieves those goals, balancing risk with return and maintaining a diverse mix of assets.
Here are the different types of investments that can help you achieve portfolio diversification.
Different Types of Investments for Diversification
Bonds are essentially loans you make to a company or a government—federal or local—for a fixed period of time. In return for loaning them money, they promise to pay it back to you in the future and pay you interest in the meantime.
When it comes to bonds vs. stocks, the former are typically backed by the full faith and credit of the government or large companies. Because of this, they’re often considered lower risk than stocks.
However, the risk varies, and bonds are rated for their quality and credit-worthiness. Because the U.S. government is less likely to go bankrupt than an individual company, Treasury bonds are considered to be some of the least risky investments. However, they also tend to have lower returns.
Different Types of Bonds
Treasurys: These are bonds issued by the U.S. government. Treasurys can have maturities that range from one-month to 30-years, but the 10-year note is considered a benchmark for the bond market as a whole. In early 2021, Treasury Secretary Janet Yellen said a 100-year bond could make sense, although the market for it would be tiny.
Municipal bonds: Local governments or agencies can also issue their own bonds. For example, a school district or water agency might take out a bond to pay for improvements or construction and then pay it off, with interest, at whatever terms they’ve established.
Corporate bonds: Corporations also issue bonds. These are typically given a credit rating, with AAA being the highest. High-yield bonds, also known as junk bonds, tend to have higher yields but lower credit ratings.
Mortgage and asset-backed bonds: Sometimes financial institutions bundle mortgages or other assets, like student loans and car loans, and then issue bonds backed by those loans and pass on the interest.
When you think of investing, you probably think of the stock market. A stock gives an investor fractional ownership of a public company in units known as shares.
Only public companies trade on the stock market; private companies are privately owned. They can sometimes still be invested in, though the process isn’t always as easy and open to as many investors.
A stock makes money in two ways: It could pay dividends if the company decides to pay out part of its profits to its shareholders, or an investor could sell the stock for more than they bought it.
Some investors are looking for steady streams of income and therefore pick stocks because of their dividend payments. Others may look at value or growth stocks, companies that are trading below their true worth or those that are experiencing revenue or earnings gains at a faster pace.
Although stocks and bonds are the more traditional assets to invest in, there are other types of investments known under the broad category of “alternatives.” These are not necessarily tied to the stock or bond market, so can provide some diversification potential.
Owning real estate, either directly or as part of real estate investment trust (REIT) investing or limited partnerships, gives you a tangible asset that may increase in value over time.
If you become invested in real estate outside of your own home, rent payments can be a regular source of income. However, real estate can also be risky and labor-intensive.
A commodity is a raw material–such as oil, gold, corn or coffee. Commodities investing has a reputation for being risky and volatile. That’s because they’re heavily driven by supply and demand forces. Say for instance, there’s a bad harvest of coffee beans one year. That might help push up prices. But on the other hand, if a country discovers a major oil field, that could dramatically depress prices of the fuel.
Investors have several ways they can gain exposure to commodities. They can directly hold the physical commodity, although this option is very rare for individual investors (Imagine having to store barrels and barrels of oil).
So many investors wager on commodity markets via derivatives–financial contracts whose prices are tied to the underlying raw material. For instance, instead of buying physical bars of precious metals to invest in them, a trader might use futures contracts to make speculative bets on gold or silver. Another way that retail investors may get exposure to commodities is through ETFs that track prices of raw materials.
Only public companies sell shares of stock, however private companies do also look for investment at times—it typically comes in the form of private rounds of direct funding. If the company you invest in ends up increasing in value, that can pay off, but it can also be risky.
A cryptocurrency is a kind of digital currency that uses encryption and coding techniques for security. These currencies are independent and separate from fiat currencies-like the U.S. dollar or euro–which are examples of money issued by a government or central bank.
There are a number of different cryptocurrencies out there: Bitcoin was the first digital currency and is the most well-known. However, cryptocurrency prices have historically been very volatile, and the market is therefore considered to be a risky type of investment.
Overview of Investment Products
A mutual fund is an investment managed by a professional. Funds typically focus on an asset class, industry or region, and investors pay fees to the fund manager to choose investments and buy and sell them at favorable prices.
Exchange traded funds (ETFs) can appear to be similar to a mutual fund, but the main difference is that ETFs can be traded on a stock exchange, giving investors the flexibility to buy and sell throughout the day. They also come in a range of asset mixes.
An annuity is an insurance contract that an individual pays upfront and, in turn, receives set payments later, typically during retirement.
There are fixed annuities, which guarantee a set payment, and variable annuities, which put people’s payments into investment options and pay out down the road at set intervals.
There are several types of derivatives but two popular ones are futures and options. Futures contracts are agreements to buy or sell something (a security or a commodity) at a fixed price in the future.
Meanwhile, in options trading, buyers have the right, but not the obligation, to buy an asset at a set price on a later date.
Recommended: How to Trade Options for Beginners
Investment Account Options
An investor can put money into different types of investment accounts, each with their own benefits. The type of account can impact what kinds of returns an investor sees, as well as when and how they can withdraw their money.
A 401(k) is a retirement account provided by your employer. You can often put money into a 401(k) account via a simple payroll deduction, and in a traditional 401(k), your contribution isn’t taxed as income. Many employers will also match your contributions to a certain point. The IRS puts caps on how much you can contribute to a 401(k) annually.
IRA stands for “individual retirement account”—so it isn’t tied to an employer. There are IRS guidelines for IRAs, but, essentially, they’re retirement accounts for individuals. IRAs allow people to set aside money pre-tax for retirement without needing an employer-backed 401(k).
Roth v. Traditional
Both 401(k) plans and IRAs come in two forms: Roth or traditional. A traditional account typically means contributions are tax-deductible and future withdrawals are taxed as ordinary income.
A Roth account essentially allows you to make qualified withdrawals down the road without paying tax on them, but all contributions now are made with post-tax income.
A brokerage account is a taxed account through which you can buy most of the investments discussed here: stocks, bonds, ETFs. Some brokerage firms charge fees on the trades you make, while others offer free trading but send your orders to third parties to execute–a practice known as payment for order flow. Investors can be taxed on any realized gains.
You might also consider enlisting the help of a wealth manager or financial advisor who can provide financial planning and advice, and then manage your portfolio and wealth. Typically, these advisors are paid a fee based on the assets they manage.
There are even a number of investment options out there not listed here—like buying into a venture capital firm if you’re a high-net-worth individual or putting funding into your own business.
It might still seem overwhelming to figure out what kinds of investments will help you achieve your goals. There are different investment strategies and finding the right one can depend on where you are in your career, what your financial goals are and how far away retirement is.
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Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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