Investing for Beginners: Your Guide to the 4 Types of Investments

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Invest: The word can present an endless amount of options, possibilities and stress. You’ve probably thought about investing — maybe you’ve contributed to your employer-sponsored 401k or tried your hand at a few stock trades. You can trust your financial advisor, use an investing app, or browse #FinTwit or FinkTok for stock tips, but do you really know how the stock market works for your unique needs?

Before you invest any time, you need to understand the different asset classes so you know where to invest in your lifetime, depending on your goals and circumstances. Each asset class incurs greater risk, and potentially greater reward, the further you go. Work these terms into your lexicon as you strive for financial independence and more.

Cash and Cash Alternatives

Cash is the first of four asset classes. Let’s say some of your funds need to be saved for the purchase of a home or vacation property, perhaps a car or a new roof. You would want to make sure that this part is in a low-risk investment that is liquid or readily available to you when you need it. You can choose to park your dollars in a money market account, a US Treasury bond, or maybe even a CD.

CD

A CD is a certificate of deposit and is similar to a savings account but holds your money for a specific period of time – six months, one year, two years, five years or more. The bank that issues you the CD will pay you interest for the selected term (classified as income), and at the end of the defined period, you will receive your principal, i.e. when the CD matures.

US treasury bond

A US treasury bond is backed by the US Treasury Department and allows the investor to make a small return (interest) on their funds over the course of a year or less. Treasury bonds are affordable to many, starting at $1,000 each, and are considered low-risk investments. As with many investments, the longer the time between purchase and maturity, the higher the return.

Money market account

A Money Market Account can be an account in a bank or a mutual fund. Money market accounts are safe and accessible when needed. You will receive a small return for allowing the institution to borrow your funds to use in their day-to-day loans to other institutions and even businesses.

Fixed income

This is a broad category, so I want to focus on a few of the more popular fixed income options. Fixed income securities work exactly as it sounds: a fixed amount of interest (income received) on a fixed schedule. Interest is generally paid semi-annually.

Municipal bonds

Municipal bonds are debt securities that can be issued by state and local governments that the investor will purchase in exchange for interest payments and repayment of principal, the principal being the original dollar amount used at the time of purchase. Municipal bonds are issued (sold) to raise money for projects like parks and bridges.

“A municipal bond may sound like a lot of jargon, but it’s simply an organization – whether it’s a company or the government – that borrows money for a period of time and agrees to pay it back. repay with interest”, explains Alexa von Tobel. (opens in a new tab) US government backed municipal bonds are meant to be low risk because we trust the government to be there to pay it back.

Interest paid on municipal bonds may be tax exempt, making them attractive to investors in higher tax brackets.

Corporate bonds

Corporate bonds are another debt security, but issued by a company to acquire the capital it needs for expansions, improvements and perhaps even acquisitions. The minimum investment is usually $1,000, just like treasury bills, and can be issued with maturities between 1 and 30 years. The longer the duration, the more sensitive the bond may be to changes in interest rates. Many investors like corporate bonds because they can invest in a company they like.

Fixed income securities carry a certain degree of risk, but they are generally lower than equities and may offer a slightly higher return than cash and cash equivalents.

Now let’s move on to the most popular of the four asset classes: equity securities.

Equity securities

When you buy a stock, you are actually buying a stock: partial ownership of a company. You are in turn called a “shareholder”. The more shares you buy, the greater your stake in the company. Being a shareholder allows you to have a voice in the company by attending shareholder meetings. Individual investors buy certain stocks for a variety of reasons, maybe they shop regularly, have a family member who works there, or just like the way they do business. Whatever the reason for which stocks are most traded and may be the most misunderstood asset class.

Some investors want to generate income with potentially less volatility from their stock portfolio, and if so, they would choose dividend-paying stocks. By owning a dividend-paying stock, you can actually “get paid” for owning shares of that company. Not all companies pay dividends, so you’ll need to work with a financial professional if your goal is to create an income-generating portfolio. Here is an example; if you own 100 shares of a company that pays an annual cash dividend of $1.50, your portfolio would generate $150, each year, for owning shares of the company. Dividends can and often do vary.

If you enjoy buying stocks that may have fallen out of favor due to certain events or changes in the economic cycle, then you are a value investor. Value investors like to buy when many others are not and will generally pay less per share than if they had bought when the company is in favor. Warren Buffet is one of the best-known proponents of value stocks. Caveat: Investing in value stocks takes patience and works best with long-term investment horizons.

Investing in companies that are at the forefront of innovation and product development can be exciting. If you have a higher tolerance for risk, growth stocks may be for you. Growth stocks are selected by most investors for their potential capital gains and not because they pay dividends, as they usually don’t.

Alternative investments

Alternative investments are the last asset class, and potentially the least liquid. Some examples include REITs (real estate income trusts), venture capital, private equity, hedge funds, and cryptocurrency. Let’s talk about one of the best known alternative investments, Hedge Funds. A hedge fund allows a group of qualified investors, usually high net worth and very high net worth, to combine their assets and employ a long-short investment strategy. If the fund manager expects the market to rise over time, he will implement a long strategy, and if he anticipates the market to fall over time, he will sell shares. The idea is that these methods have the potential for above average returns. Keep in mind that hedge funds can be risky investments and generally require a minimum liquid net worth of $1 million and/or an annual salary of $200,000.

An understanding of asset classes and how an investment portfolio is constructed, based on risk tolerance and financial goals, is of utmost importance. Once you are ready to get into fixed income, stocks and/or alternative investments, I would meet with a financial adviser – working with a professional can save you time and money in the long run and many advisors will take longer to make sure you have a basic understanding of your portfolio and holdings. You don’t need to know everything, but having an understanding of the basics will help you build a solid foundation.

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