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Types of Investments: Everything You Need To Know
 

Next time you drive to work or take a trip to the grocery store, take a look at all the different types of vehicles on the road next to yours. You’ll probably see a fair share of family SUVs, powerful pickup trucks, popular sedans, and maybe even a fancy sports car . . . the list goes on and on.

While we all drive vehicles that come in all kinds of shapes and sizes, we all want the same thing—a car or truck that’s reliable, meets our needs, and will take us where we need to go.

When it comes to our financial and retirement goals, investments (the financial industry sometimes calls them investment vehicles) work the same way. They can help you get closer to your ultimate destination.

What Is an Investment Vehicle?

An investment vehicle is any financial account or product that is designed to help you make money on top of the money you put into it. They exist to help investors like you reach your investing and retirement goals.

But not all investment vehicles are created equal. Some investments have a proven track record of helping millions build wealth over the long haul, while others could leave you stranded in a ditch somewhere along the way. It’s important to figure out which one is which!   

Understanding How Investments Work

Investors have plenty of options to choose from. You’ve got your more conservative, low-risk options (like bonds or certificates of deposit), the more aggressive, high-risk choices (like single stocks and cryptocurrencies), and then there are plenty that fall somewhere in the middle.    

Here are a few features all investments have in common:

Expected Return

An investment’s expected return simply refers to the money you can expect to make (or lose) over a specific period of time. That’s a big deal, since the whole point of investing is to make money on the money you invest. Expected returns depend on lots of factors, like market conditions, economic trends, and the nature of the investment itself.

Risk

All investments carry at least some level of risk, which in this case means the potential to lose money. Some types of investments are riskier than others, which is why you should never put money into an investment you don’t understand. Always ask questions until you fully understand the risks involved.   

Liquidity

Liquidity is investor-speak for how easy it is to access to your money or how quickly an investment can be bought or sold in the market without significantly impacting its price. Money in a bank account, for example, is very liquid since you can access those funds at any time. Real estate, on the other hand, is a less-liquid investment because it takes more time and effort to sell a property and turn it into cash.

Cost

Investments come at a price, which includes the actual price of the investment along with any fees, commissions, and other expenses that come with it. High costs can eat into your profits over time, so it’s important to ask your investment pro about the fees you’ll have to pay and how they’ll affect the growth of your investments.

Structure

When people talk about the structure of an investment vehicle, they’re usually talking about how the investment is organized and operates. For example, is the investment managed by a group of investment pros like a mutual fund? Or is it set on autopilot like an index ETF? Does it pay a fixed rate of interest like a CD instead of growing (or falling) in value like a single stock? The structure can impact how the investment performs over time, how it’s taxed, and how easily you can buy or sell shares.

Types of Investments

Alright, buckle up. There are a lot of investments out there . . . and we’re going to help you break down some of the most common options and share our thoughts on them—good and bad.

Mutual Funds

Mutual funds are professionally managed investments that allow investors to pool their money together to mutually invest in something—like stocks, bonds, or other investment options.

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Stock mutual funds let you invest in shares of stock from dozens or even hundreds of companies at once, from the largest and most stable to the newest and fastest growing. They have teams of managers who choose companies for the fund to invest in based on the fund type.

We like mutual funds because spreading your investment across many companies helps you avoid the risks that come with investing in single stocks. Since mutual funds are actively managed by a team of investment pros picking stocks with the goal of consistently outperforming the stock market or their category’s index, they’re a great option for long-term investing.

Exchange-Traded Funds (ETFs)

ETFs are basically a cross between mutual funds and single stocks. They’re like mutual funds since they pool together money to buy a bunch of investments—like single stocks—into a portfolio. And they are like single stocks since they’re designed to be traded on a market exchange throughout the day (mutual funds can only be bought and sold at the end of the trading day).

Most ETFs don’t use teams of managers to choose stocks for the ETF to invest in, and that usually keeps their fees low. ETFs allow you to trade investments easily and often, so a lot of people try to time the market by buying low and selling high—but that gets really messy.

We prefer a buy-and-hold investing strategy—which means hanging on to your investments over time and keeping a long-term view, instead of trying to “time the market” or selling on a whim if the market has a bad day.

Index Funds

An index fund is a type of mutual fund that mirrors a particular financial market index (an index helps investors measure the performance of a particular sector of the stock market or even the stock market as a whole). The most common example is the S&P 500 index fund, which invests in companies that are in the S&P 500 index.

While index funds are diversified, have lower fees, and provide predictable returns, they won’t have a team of investment pros trying to beat “average” market returns.

If you’re looking for a good place to park your savings for five to 10 years, index funds are great because they are low risk and low cost. But when it comes to your main retirement savings, you can do better. With help from an investment pro, you can find funds that have a long track record of strong returns that beat stock market indexes like the S&P 500.

Single Stocks

A stock is an investment that gives investors like you a small piece of ownership in a company. So when you buy shares of a company’s stock, you become a part-owner of it. With single stock investing, the value of your investment rises and falls based on the performance of an individual company.

We don’t recommend single stocks because investing in a single company is like putting all of your eggs in one basket—a big risk to take with money you’re counting on for your future. If that company goes down the tubes, your nest egg goes with it. No thanks!

Target Date Funds

target date fund is an investment vehicle that automatically changes your investments from aggressive (high risk, high reward) to conservative (low risk, low reward) options as you get closer to retirement.

What does that mean, exactly? With a target date fund, you’ll start out with a portfolio that includes more stocks (think single stocks along with growth and aggressive growth mutual funds). But then, as you get older and get closer to your “target” retirement date, your fund will automatically shift from stocks to investments like bonds, CDs and money market funds that are traditionally considered less risky.

But there’s a big problem with target-date funds: They can keep your nest egg from reaching its full potential. People are living longer than they think they will after retirement, and adjusting your investment portfolio to a more conservative approach can put you at risk of outliving your retirement savings. And you don’t want to end up in that position. 

Certificates of Deposit (CDs)

certificate of deposit is a type of savings account that lets you save money at a fixed interest rate for a set amount of time. Usually that interest rate is slightly higher than the typical savings account, but there’s a catch—the bank will charge a penalty if you take money out of a CD before a certain date (also known as a maturity date).

But the problem with CDs as an “investment” is simple: Their interest rates usually don’t keep up with inflation.1 That’s why we like to call them “certificates of depression” and don’t recommend them. While CDs could be useful for setting aside money for a short-term goal (even then, a high-interest savings account or money market account is probably a better option), they aren’t good for long-term money goals that take more than five years to reach.

Bonds

Bonds let companies or governments borrow money from you. In return, you earn a fixed rate of interest on your investment, and the company or government repays the debt when the bond reaches maturity (aka the date when they have to pay it back to you).

Even though bonds’ values rise and fall like stocks and mutual funds, they have a reputation for being “safe” investments because they experience less market instability.

But there are plenty of holes in that theory. When you compare investments over time, the bond market doesn’t perform as well as the stock market.2 Earning a fixed interest rate might protect you in really bad years, but it also means you won’t profit from the really good years. Plus, as interest rates go up, the value of your bond goes down. So you can still lose money by investing in bonds.

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Real Estate

When done the right way, real estate could become one of the most important investment vehicles in your portfolio. Whether you’re purchasing your own home, saving up to buy a rental property, or plan to flip houses like one of those HGTV power couples, owning real estate can be a great way to build wealth.

According to the Federal Housing Finance Agency, home prices have increased each year by 4.7% on average since 2000 (and since 2012, the average rate of growth has been 7.5%).3

But keep in mind that owning real estate isn’t for the faint of heart. It takes work to handle the responsibilities of owning a rental property—from ongoing maintenance, emergency repairs and insurance to finding the right renters who’ll pay on time and won’t burn the place down. Plus, flipping homes is a lot less glamorous than they make it seem on TV.

A lot of people get way too excited about the potential to make money in real estate. They go deep into debt in a desperate attempt to get rich quick as a real estate mogul, only to end up broke . . . don’t do that! If you’re going to invest in real estate, start small, wait until you’re debt-free (including your home), and max out your retirement accounts. Then, pay for your properties in cash, stay local, and work with a real estate agent to help you find the right property for your situation.

Real Estate Investment Trusts (REITs)

REITs are basically mutual funds that own or finance real estate. Like mutual funds, REITs sell shares to investors and use that money to buy and manage properties within the fund. REITs generally make money for their investors in several ways, including rent payments, appreciation of property values, and strategically buying and selling properties for a profit.

REITs have made a lot of progress as a legitimate way to invest in real estate over the past decade, and they can be especially appealing if you’re not interested in managing your own rental properties and you’ve already maxed out your tax-advantaged retirement accounts—like your 401(k) and Roth IRA.  

Fixed Annuities

Fixed annuities are complex accounts sold by insurance companies and designed to deliver a guaranteed income for a set number of years in retirement.

We don’t recommend annuities because they’re often expensive and charge penalties (called a surrender charge) if you need to get to your money during the first few years after you buy one.

Variable Annuities (VAs)

Variable annuities don’t offer the same guaranteed payments that fixed annuities offer. Instead, they’re basically mutual funds stuffed inside an annuity, which means your payments in retirement will depend on the mutual funds’ performance. That’s what makes them variable.

While variable annuities do give you an additional tax-deferred option for mutual fund investing if you’ve already maxed out your 401(k) and IRA savings accounts, you lose a lot of the growth potential because annuities have so many fees that eat away at that growth. And VAs also have surrender charges.

Cash Value or Whole Life Insurance

Cash value or whole life insurance is often sold as a way to build up your savings and provide life insurance for your whole life. It costs way more than term life insurance because it’s insurance that’s trying to double up as an investment account too.

Sure, it might sound like a good idea at first, but it’s definitely not. So much of your premiums go to pay commissions and fees that there’s hardly any left to build up any cash value. And here’s the kicker—if you do manage to build up any savings, your beneficiaries don’t get any of it! They only receive the face value of the policy (yeah, it’s pretty dumb).

That’s why we only recommend term life insurance (life insurance that only covers you for a set period of time like 15–20 years), with coverage that equals 10–12 times your income. That way, if something happens to you, your family will be able to replace your salary. Not sure how much coverage you’ll need? You can run the numbers with our Term Life Calculator.

Cryptocurrency

Cryptocurrencies like Bitcoin and Dogecoin (remember when that was a thing?) are like a form of digital cash. But unlike traditional currencies like the dollar or the euro, they’re not backed by any government or central bank.

While you can use cryptocurrency to buy some things, a lot of people see it a type of investment. But is cryptocurrency a smart investment? If the past few years have shown us anything, the answer is a resounding no.

Cryptocurrency prices can swing up and down faster than any rollercoaster you’ve ever ridden, with its value open to rapid and significant shifts. Market demand, new regulations, and technological advancements can send the price of cryptocurrency into a nosedive . . . and trust us, this isn’t a ride you want to get on. 

Cash and Cash Equivalents

Cash equivalents are investments or assets that can be quickly and easily converted to cash (like money inside a money market account or short-term government and corporate bonds). 

You might find some conservative investment portfolios have cash as a buffer or a way to protect the wealth what you’ve already built, but you’re not going to see investors using cash equivalents for huge gains.

Of course, cash does have a place within your financial plan—just not as an investment (cash equivalents barely keep up with inflation). However, cash stashed inside high-yield savings accounts or money market accounts is perfect for your emergency fund and for short-term savings goals (like saving up for a down payment on a home or to buy a new-to-you car) because it’s easy to access whenever you need it, and won’t be affected by short-term swings in the stock market.

Commodities

Commodities are things like precious metals (gold, silver and platinum), energy resources (oil and natural gas), and agricultural products (wheat and cattle) that are used in the production of other goods and for trade.

Some investors are drawn to commodities as a way to diversify their investments and protect against inflation. But when you take a closer look, the reality is that commodities come with some big, glaring risks.

First, the price of commodities can often swing wildly in different directions based on global events, market supply and demand, and even unpredictable weather conditions. In times of uncertainty, people rush to buy precious metals like gold assuming it’s a safe investment. But when was the last time you saw someone pay for their groceries or gas in gold coins? 

And second, investing in commodities can be extremely complicated. In most cases, you usually have to buy or sell commodities through something called futures contracts, which are agreements to purchase (or sell) a specific amount of a commodity at an agreed-upon price on a future date. This kind of investing can be very dangerous if you don’t know what you’re doing and could lead to steep losses . . . just do yourself a favor and steer clear.

Collectibles

Yup, believe it or not, your grandma’s old stamp collection and those boxes in your basement filled with Pokémon cards could be considered “investments” by some folks.

A collectible can be pretty much any item someone collects that others are willing to spend money on—sometimes a lot of money. From fine art to classic cars, collectibles come in all shapes and sizes.

While there are people who collect things like classic comic books and vintage baseball cards as a hobby or because it’s their passion, some collectors hold on to them hoping that they’ll skyrocket in value over time.

Like other forms of alternative investments, the price of a collectible can be very difficult to predict. That first edition Beanie Baby that’s been collecting dust for years could be worth thousands of dollars at some fancy auction house someday . . . or you might be lucky to find someone willing to spend more than $10 for it at a garage sale. It all depends on what someone else is willing to pay for it.

It could be fun to pick up collectibles as a hobby, but just don’t stake your retirement future on them. 

What Is the Best Investment for Retirement?

While some of these investment vehicles we talked about might make sense in certain situations, the best place to start is with growth stock mutual funds. Those are far and away our favorite type of investment for retirement investing.

Like we mentioned earlier, growth stock mutual funds allow you to experience the upsides of investing in the stock market while also lowering your investment risk by spreading your investments across dozens or even hundreds of different company stocks (that way you’re not staking your entire financial fortune on the success and failure of a single stock).

We also recommend going a step further by working with an investment professional to help you spread your investment dollars evenly across four types of mutual funds:

  • Growth and Income Funds (Large Cap): These funds provide slow and steady growth by investing in large companies that are generally much more stable than smaller companies.
  • Growth Funds (Medium Cap): These funds invest in medium-sized companies, which creates potential for moderate growth and volatility. These funds are more likely to mirror the growth of the stock market.
  • Aggressive Growth Funds (Small Cap): Also called emerging market funds, these funds are often the “wild child” of your portfolio. Usually invested in lots of startups with the potential for rapid growth, you could easily see big gains over one stretch of time and equally big losses in the next.
  • International Funds: Made up of company stocks from around the world, international funds help you further diversify your money by investing outside of the U.S.

When you invest 15% of your gross income into tax-advantaged retirement accounts—like your 401(k) and a Roth IRA—with these four types of mutual funds, you’re setting yourself up to build a nest egg that’ll last throughout your retirement.

 

Next Steps

  • Use our Retire Inspired Quotient (R:IQ) tool to help figure out how much money you’ll need to retire on your terms and how much you’ll need to save each month to get there.
  • Do an annual review of your investments. Figure out if you need to adjust your asset allocation or how much you’re investing each month so you can stay on track with your investing goals.     
  • Get in touch with an investment pro. Our SmartVestor program can help you find pros in your area who can help you save for retirement and walk you through all your investment options.
Find Your SmartVestor Pro

This article provides general guidelines about investing topics. Your situation may be unique. If you have questions, connect with a SmartVestor Pro. Ramsey Solutions is a paid, non-client promoter of participating Pros. 

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About the author

Ramsey

Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books (including 12 national bestsellers) published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners. Learn More.

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