Learning to invest can be a struggle. It seems difficult at first to understand the numerous types of investments available. The pundits on TV spout financial jargon at a dizzying pace. Before you can decide which investments are right for you, you need to be able to understand each option. Here are 12 different investments with an overview of how they work.
Stocks represent fractional ownership in a business. Ownership entitles you to vote for the company’s board of directors and to receive your portion of distributed income. Owners of company’s stock are called shareholders and they can gain in two ways. The share value appreciates as the company succeeds allowing the owner to sell shares for a capital gain. Also, the company can pay its profits to the shareholders in the form of a dividend. Stocks are a very traditional investment. They have the potential to produce high returns and they make up an important part of most investment plans.
A bond is a loan made to a corporation or government entity. They sell in $1,000 increments. The borrowing corporation or government has the legal obligation to pay interest each year on the loan and at maturity they must pay off the loan with a balloon payment. Investors may hold the bond until maturity or may sell the bond early on the secondary market. Bonds also have a place in most investment plans as their value is more stable than stocks.
3. Real Estate
Real Estate is property such as land, a house, or commercial buildings. Real estate investors gain when the value of the property rises and is sold for a profit. They also gain when the property is held and leased out to provide monthly rental income. Real estate is an important asset class because it does not grow in sync with stocks or bonds.
4. Mutual Funds
A mutual fund is a type of Investment Company which employs professionals to manage a large investment portfolio consisting of many stocks and or bonds. Owning a mutual fund share entitles you to participate proportionately in the gains and losses of the fund and to receive the dividends and interest it generates. Mutual funds provide diversification and professional management.
An annuity is a contract with an insurance company offering investments with guarantees. The guarantees differ depending on the type of annuity. Guaranteed lifetime income is the most basic guarantee available, but safety of principal is sometimes offered. Annuities come in two broad categories, deferred and immediate. They can be further sub divided into variable and fixed categories. Variable annuities have stock/bond market risk. Fixed annuities earn a stated rate of interest.
6. Real Estate Investment Trust (REIT)
Real Estate Investment Trust is a type of corporation organized under a trust indenture and specializes in buying, selling and managing actual real estate property. Their aim is to manage the properties for rent and also to sell the properties for profit. They can be thought of like a mutual fund that specializes in real estate. REITs allow investors to have a diverse portfolio of real estate for small dollar amounts. REITs have higher dividends than stocks due to special tax status which they receive.
7. Certificate of Deposit (CD)
Certificates of Deposit are a type of bond made with banks. CD owners loan money to the bank for a stated length of time and receive a stated rate of interest on their money. In the United States bank CDs are insured by the FDIC. Safety of principal is their primary purpose.
8. Unit Investment Trust (UIT)
A Unit Investment Trust is another type of Investment Company. It is similar to a mutual fund in that it offers a diverse range of investments for small dollar amounts. Unlike mutual funds UITs have a set termination date. The investment may have gains or losses at the termination date depending on how the securities within the trust fared.
9. Master Limited Partnership (MLP)
A Master Limited Partnership is a partnership that trades on public stock exchanges. In the U.S. the government taxes them as a limited partnership and not as a corporation. Because of this the business does not pay taxes at the corporate level providing they pass at least 90% of their profit to the owners instead of retaining it in the business. Like REITs, this causes dividends from MLPs to be higher than normal stocks. In the United States, MLPs must operate in the energy industry and industries related to natural resources. Owners are referred to as unit holders instead of stock holders.
10. Preferred Stock
A preferred stock is a type of stock designed as a hybrid between stocks and bonds. Normally, owners to not have voting rights in the company, but they have favored status in the distribution of dividends. Companies must pay dividends to the preferred stock holders before they may pay any dividends to the common stock holders. In the event of a liquidation proceeding (bankruptcy), preferred stock holders get paid after the bond holders and before the common stock holders.
A contract in which the owner of the contract has the obligation to a buy or sell certain securities at a set price in the future. The value of a futures contract is derived from the value of the underlying securities.
An option contract is another derivative investment strategy in which owners have the right but not the obligation to buy or sell a security at a future date for a fixed price. Trading options involves contracts known as Calls and Puts. Calls give you the right to buy a stock at a fixed price in the future and Puts give you the right to sell stock at a fixed price in the future. Like futures, an option contract’s value is derived from the value of the underlying security.
Many people think an IRA is a type of investment that gains or loses money. It is in fact not a type of investment but rather a tax coding that covers an entire account that has any number of different investments within it. When an account is an IRA it means that the taxes on all interest, dividends and capital gains in the account are deferred until the date you withdraw the funds. Owners receive a tax deduction when they contribute money to the account and pay income tax when they withdraw the money. A newer form of the IRA is the Roth IRA in which owners to not receive a tax deduction for contributions, but they do not have any income tax when they withdraw the money.
Now that you understand the basics of each investment you can choose the ones that seem most appropriate for you and begin to focus your learning in that area. All of these investments may be purchased and sold through a brokerage account.