Once you’ve made the decision to invest your money, there are two important decisions you need to make: how much to invest and where to invest it. It’s important to understand your options as well as the risks associated with each of them.
There are three main types of investments:
- Cash equivalent
You can invest in any or all three investment types directly or indirectly by buying mutual funds Another option is to invest in tax-deferred options, such as an IRA or annuity.
When you invest in stocks, you’re buying a share of ownership in a corporation and become a shareholder. Companies sell shares of stock to raise money for start-up or growth.
There are two types of stock:
- Common stock – Shareholders have a percentage of ownership, have the right to vote on issues affecting the company and may or may not receive dividends.
- Preferred stock – Shareholders are generally entitled to dividends at specified intervals and in predetermined amounts, but they don’t typically have voting rights.
Investment returns and risks for both types of stocks vary, depending on factors such as the economy, political scene, the company's performance and other stock market factors.
When you buy bonds, you lend money to the government or to a company. Bonds are issued for a set period of time during which interest payments are made to the bondholder. The amount of these payments depends on the interest rate established by the issuer of the bond (the government or company) when the bond is issued. This is called a coupon rate, which can be fixed or variable. At the end of the set period of time (called the maturity date), the bond issuer is required to repay the par, or face value, of the bond (the original loan amount).
Bonds are considered a more stable investment compared to stocks because they usually provide a steady flow of income. But because they’re more stable, their long-term return probably will be less when compared to stocks. Bonds, however, can sometimes outperform a stock’s rate of return, depending on the particular stock.
Keep in mind that bonds are subject to a number of investment risks including credit risk, repayment risk and interest rate risk.
Cash equivalent investments, such as savings accounts, money market funds or certificates of deposit (CDs), protect your original investment and let you have access to your money.
These types of investments generally deliver a more stable rate of return. On the other hand, the rate of return (after taxes are paid) is often so low that it doesn’t keep pace with inflation. They’re not designed for long-term investment goals such as retirement.
Here are some types of cash-equivalent investment types:
- Money market – A fund usually invested in Treasury bills, CDs and commercial paper from large established institutions. They are typically safe, liquid investments.1
- Certificate of deposit – A fixed period, interest-bearing investment with a bank or savings and loan. An FDIC-insured CD is a low-risk investment.
- Bank savings account – A bank account that generally provides a low, guaranteed, fixed rate of return.