Learning the basics of investing is like learning a new language. Whether discussing stocks, bonds, and other investment vehicles to structures, entities, and dollar cost averaging, it's no wonder many beginning investors feel like they're in uncharted waters. The good news is that once you have mastered the language and certain investing basics, you'll better understand how much of this works. To assist you on that journey, here is a look at the handful of the most common types of investments you will encounter in your lifetime.
We'll also talk about a few other relevant topics, such as the legal entities - limited liability companies and limited partnerships - through which investors tend to make investments in things like hedge funds and private equity funds.
Stocks and Bonds
Without a doubt, owning stocks has been the best way historically to build wealth. And for more than a century, investing in bonds has been considered one of the safest ways to make money. But how do these investments work?
Stocks are pretty simple: they're shares of ownership in a specific company. When you own a share of Apple, for example, you own a tiny piece of that company. Stock prices fluctuate with a company's fortunes, and also with the economy at large.
When you buy a bond, meanwhile, you are lending money to the company or institution that issued it. In the case of a school bond, for instance, you are lending money to the school district to build a new high school or improve classroom conditions. Buying a bond issued by a company means you're lending money to that company, which it can use to grow the business.
Investing in Mutual Funds
One of the most popular ways to own stocks and/or bonds is through mutual funds. In fact, most people are statistically less likely to own individual investments than they are shares of companies through mutual funds held in their 401(k) or Roth IRA.
Mutual funds offer many benefits to investors, particularly to beginners who are just mastering investing basics. They're pretty easy to understand and allow you to diversify your investments over more companies. However, mutual funds also have a few serious drawbacks: they charge fees, which can eat into your profits, and they may boost your tax bill, even in a year when you don't sell shares.
Real Estate Investments
The world is full of people who are convinced that real estate is the only investment that makes sense. Whether you subscribe to that philosophy or not, there are more ways than ever to add real estate to your portfolio.
Yes, you can buy a home for yourself, or properties to rent. But you also can purchase a security called a real estate investment trust (REIT), which combines the benefits of stocks with the tangible property of land, shopping malls, apartment buildings, or almost anything else you can imagine.
Investing Structures and Entities
When you move beyond stocks, bonds, mutual funds, and real estate, you encounter different types of investment entities. For example, millions of people will never own a share of stock or a bond. Instead, they invest their money in a family business, such a restaurant, retail shop, or rental property. Yes, these are businesses, but you also should consider them investments, and treat them accordingly.
More experienced investors likely will invest in hedge funds or private equity funds at some point in their life, while others will buy shares of publicly traded limited partnerships through their broker. These special legal structures can have big tax implications for you, and it is important you understand how investing through them can both benefit, and potentially harm your pocketbook.
Investing in a Bad Economy
It's the nature of the world that sometimes bad things happen. When they happen to your investments or savings, you don't need to panic. Sometimes, you need to take a hit before you can make some money again, and holding on until the recession ends is the best plan.