Note: If you are interested in making investments with your money after reading this article, we recommend you check with a financial adviser who can provide you recommendations that fit your unique needs and advise you of any tax implications.
One of the tips almost everyone has heard about saving for retirement is that you need to diversify your portfolio, but what does that even mean? Put simply, it means having different types of investments to help you protect yourself financially.
Having different types of investments helps ensure that at least some of them are performing well at any given time. This can help you build wealth in the long run and mitigate temporary losses in certain areas of your portfolio. Different investment types are also useful for different things. Check out 12 different investment types below to understand the pros and cons of each.
What is it?
Cash investments aren’t bills in the mayo jar under your mattress. They’re
low-risk investments such as money market accounts, certificates of deposit or
even cash in your savings account.
Pros. Cash investments are easy to access or have short-term returns. That means the money is more likely to be available to you to use as needed for current expenses.
Cons. Cash investments typically don’t yield high returns. They’re generally better for short- or long-term savings to stabilize your finances rather than build your wealth.
What is it? Stocks let you invest in specific companies and reap a share of their profits. You can earn money by selling the stock when the price goes up or by receiving dividends, which are a portion of the company’s profits paid to shareholders periodically. However, not all stocks pay dividends.
Pros. When you
invest in a company that grows rapidly or sees great profits, you can make a
lot of money, even in a short amount of time. A varied stock profile can help
you make a good return over time.
Cons. The stock
market is volatile, and there are no guarantees. You can also see large losses,
especially in the short term.
What is it?
Bonds are investments that involve you lending money to a corporation or
government entity. The entity agrees to pay the bond back upon the maturation
date with extra interest so that you earn a profit.
Pros. You know
how much your returns will be because the amounts are fixed, and bondholders
are always paid before stockholders, which can help mitigate risks.
Cons. Bonds can take many years to mature, making them less liquid. You typically have to wait until the full maturation date, which can be as long as 30 years, to cash out bonds.
What is it?
Mutual funds are investments in a variety of assets, including money market
accounts, bonds and stocks. Many investors put money into the mutual funds, and
each takes a return according to what they invested. Typically, these funds are
managed by broker firms or financial advisers.
Pros. Mutual
funds are a good way to diversify because they’re a diversified investment in
themselves, which can also help mitigate the risk of loss. Some people also
like that the funds are controlled by professionals.
Cons. You don’t
have control of the mix of what’s in your mutual fund. You also pay fees for
the management of the fund.
What is it?
Index funds are a specific type of mutual fund that are designed to align with
a specific market index such as the Dow Jones or the S&P.
Pros. You can
easily understand how your investment is faring by following the rise and fall
of the major index in the news. These also tend to be designed to create low-risk
and long-term, steady gains.
Cons. You won’t
make large short-term gains, and you may experience large short-term losses
during periods of recession.
What is it?
Exchange-traded funds (EFTs) are groupings of assets similar to mutual funds,
but they’re traded more like stocks. They also follow one of the major indexes
like index funds.
Pros. EFTs let
you own a variety of stocks at a lower price point, and because one action buys
and sells all stocks within the EFT, it can cut down on broker fees.
Cons. You don’t
have as much liquidity and flexibility because you can’t buy or sell stocks
that are part of an EFT without taking action on the entire investment.
What is it? CDs are offered by financial institutions such as banks. You agree to leave a sum of money in an account for a period of time, and the bank shares the interest rate it earns on that money with you once that time period is over. Typically, the periods last from three months to five years.
Pros. CDs are
extremely low risk as there is a fixed and guaranteed return. They’re usually also
FDIC-insured.
Cons. The rate
of return is fairly low. You also can’t liquidate a CD before the maturity
period is reached without paying penalties.
What is it? Retirement plans include 401(k)s, IRAs and pensions. Typically, these are plans you pay into out of pretax income during your life to save money specifically for use during your retirement years.
Pros. Retirement plan contributions are often pretax, which can reduce your current tax burden. If you have an employer-sponsored retirement plan, the employer might match your investment, which can help you save faster.
Cons. The IRS
limits pretax contributions per year for all types of retirement plans. There
are also steep tax penalties for withdrawing retirement savings early.
What is it? Annuities are a type of insurance product. You make premium payments over a certain amount of time, and when the policy matures, cash payments are made to you. Cash payments might be made monthly, quarterly or annually, depending on how the annuity is structured.
Pros. Annuities
can be fairly safe investments if the company is stable because they’re a
written contract that if you make certain payments, you’ll get cash payouts in
the future.
Cons. If you
stop paying premiums for any reason, you can forgo all your investment.
Annuities can also be complex and hard to understand, so it’s important to
consult with an accountant or financial advisor before investing in one long-term.
What is it? Cryptocurrencies
are digital currencies such as bitcoin. They are not tied to the performance of
the dollar, and they’re mostly based on blockchain technology.
Pros. Because they aren’t linked to dollar performance, cryptocurrencies can continue to perform when other economic vehicles are failing. They’re also more difficult to track.
Cons.
Cryptocurrency and cryptography can be a complex, difficult topic for people
who are not well versed in it. You might also find that cryptocurrency is
harder to spend, as many providers of goods or services have not yet caught up
to this payment method.
What is it?
Commodities are goods such as livestock, energy or metal. You can invest in
these things on the commodities market.
Pros.
Commodities often react opposite to stocks and bonds, making them good for
diversification. They also do well with inflation.
Cons.
Commodities are extremely volatile, which means you could experience large
gains or losses in the short term.
What is it?
Low-risk investment options are those that almost certainly ensure a return on
your investment. Savings accounts and CDs are examples of low-risk options.
Pros. It’s
almost impossible to lose money with the lowest-risk investments. They also tend
to be simple and easy to understand.
Cons. You won’t get a high rate of return, especially in the short term. For example, average savings accounts offer returns ranging from a fraction of a percent to around 2%.
While there are websites and apps—such as Stash or Acorns – that can help you research investment options, the best step you can take is to contact an experienced financial advisor and create a plan of action that supports your goals and needs.
