There is a ton of different types of investment products out there, with something to fit just about any desired objective and tolerance for risk. Before making an investment, though, it's important to consider important factors such as your investment time horizon, tax situation, and risk appetite.
Another thing to consider is the type of account in which to hold an investment. In a brokerage account, investment gains are taxable in the year they occur and there is no restriction on when money can be withdrawn from the account. Compare this with plans such as individual retirement accounts (IRAs). In an IRA, taxes are deferred on investment earnings until withdrawn, but there are tax penalties if money is withdrawn from an IRA before the account owner reaches age 59 ½. Once you decide on the type of account that best fits your needs, it will be time to decide on what type of investments to select. This article will examine a few of the most popular types.
A stock is a type of investment that represents an ownership stake in a corporation. An initial public offering (IPO) is the process by which a corporation issues stock shares to the public. By holding an IPO, a corporation is able to raise capital to run or expand their business. Once stock shares are issued, they are bought and sold among investors on the open market known as a stock exchange. Stock prices fluctuate throughout the day, and are subject to investor demand. Aside from selling appreciated shares, an investor can profit from stocks if the corporation decides to share some of their profits with investors in the form of a dividend.
Like stocks, bonds are also issued in order to raise capital. Instead of an ownership stake, however, a bond represents a debt between the issuer and the investor. By purchasing a bond, the investor loans money to the issuer. All bonds have a duration that is stated in months or years. During the duration of the bond's life cycle, the issuer will make interest payments to the investor. Once the bond matures, the issuer will return the initial investment along with a final interest payment. As interest rates fluctuate, so do the values of existing bonds. Generally, interest rates and bond values have an inverse relationship. The most common issuers of bonds are corporations and governments.
Annuities are long-term insurance contracts intended for retirement planning. By purchasing an annuity, you exchange a purchase payment (or series of payments) for a stream of guaranteed lifetime income. Immediate annuities offer income that begins right after purchase, while deferred annuities allow the investment to grow for several years – or even decades – before payments begin. There are three types of deferred annuities: fixed, which grow at a guaranteed rate of interest; indexed, which can grow based upon the performance of a securities index; or variable, which can grow depending upon the performance of the underlying subaccounts. Subaccounts function in a way that is similar to mutual funds. Annuities also offer tax-deferred growth on earnings.
Mutual funds are investment companies that pool money from many investors and invest the money according to a stated investment objective. Capital appreciation is an example of an investment objective. A funds manager investing for capital appreciation would likely use fund assets to buy stocks that they believe will increase in price. Other examples of investment objectives are capital preservation, or fixed income. Mutual fund shares are purchased directly from the fund company, and the fund company redeems the shares once the investor is ready to sell them. This structure is called an "open-end" fund. Profit from mutual funds can come in the form of selling appreciated shares or by receiving income in the form of dividends or interest from the fund's holdings. Mutual fund shares are priced once per day.
Exchange-traded funds (ETFs) are similar to mutual funds in that an ETF is a professionally managed portfolio of money from many investors, but there are some key differences between the two investments. Unlike the open-end structure of mutual funds, ETFs are closed-end. This means that there is only one offering of ETF shares, and the shares are then bought and sold on an exchange – much like stocks. Also, unlike mutual funds, ETF share prices fluctuate throughout the day. In recent years, indexed ETFs have gained massive popularity. Instead of being actively managed, index funds track the performance of a stock market index such as the S&P 500. This passive method of investment management allows the fund manager to charge very low fees as compared to actively managed funds.
Less common investments that appeal to specific niche sectors are referred to as alternative investments. Precious metals are one example of an alternative investment. Metals such as gold and silver have long been considered a store of value and a hedge against inflation. Precious metals tend to perform well during times of market volatility. Real estate investment trusts (REITs) are another type of alternative investment. A REIT buys, sells, and manages commercial or residential properties and distributes the profits to investors. Oil and gas partnerships are a speculative type of alternative investment that seeks to extract precious natural resources from the earth.