Understanding Different Types of Investments

With so many choices and various degrees of market risk involved, it's wise to learn about each investment type and choose which is most suited to your individual goals. Here's what to know.

What Are the Different Types of Investments?

Some of the main investment types that investors use for their financial goals are stocks, bonds mutual funds and exchange-traded funds. You may invest in all these security types, a combination of investments or just one investment type. But the best idea is to understand how the different investment types work and to choose what's most suitable for your needs. Of course, there is one important thing to remember of all investments: They do not guarantee growth and have the potential for both gains and losses.

Stocks

These are equity securities that represent ownership in a business. Shares of stock are offered through a stock exchange for the purpose of raising capital for the issuing company. From the investor perspective, the ownership that shares of stock provide may enable the investor to share in the profits of the issuing company.

Dating back to the inception of the stock market in 1926, the annualized excess return on U.S. stocks has been about 10.9%.¹ While this average return is high, investors should keep in mind that it is not possible to invest in an index and stocks have high relative market risk. For this reason, stocks may be appropriate for investors who can tolerate fluctuations (ups and downs) in the value of the investments they choose to make.

Bonds

Bonds are fixed-income investment securities that represent a loan to the issuing entity, such as a corporation, municipality or the U.S. Treasury. The issuing entity will pay interest, called the coupon rate, for a set period of time and then pay back the principal at the end of the term, which is the maturity date. Returns for bonds are typically more stable than stocks, but bonds can still decline in value.

Mutual Funds

Mutual funds are pooled investments that use the money provided by the investors to buy other securities that are held in one portfolio. Put differently, mutual funds are like baskets that hold other investments, such as stocks, bonds or a combination of investments. Mutual funds are commonly used in 401(k) plans and individual retirement accounts (IRAs).

Mutual Funds can be appropriate for investors who want the convenience of holding a diversified and managed portfolio in just one investment security. Investors should keep in mind that mutual funds carry market risk and that one fund may not be sufficient for diversification purposes.

ETFs

An exchange-traded fund, or ETF, is a basket of securities that tracks an underlying index and trades similar to stocks. For example, if an investor wanted to buy a basket of securities that tracks the S&P 500 index, they could buy an ETF to do that. And like stocks, ETFs can be bought or sold during the day, whenever the stock market is open.

ETFs can be appropriate for investors who want a way to invest in a security that seeks to track the performance of an index.

Investing for Retirement

Stocks, bonds, mutual funds and ETFs are typically best suited for investors who are willing to accept market risk in exchange for long-term returns that can match or beat the rate of inflation. For this reason, these types of investments can be appropriate for long-term savings goals, such as retirement, and may be suitable for 401(k) plans and IRAs. Annuities are also worth considering, as they can provide guaranteed income after you stop working.

401(k)s

This is an employer-sponsored retirement savings account that an employee can choose to contribute to. Employee contributions are made through payroll deductions, and the employer may offer matching contributions. It's a good rule of thumb to contribute at least enough to a 401(k) to receive the full employer match if one is offered.

IRAs

An individual retirement account, or IRA, is an account you can open and manage independently. Accordingly, these accounts tend to offer a great deal of flexibility when it comes to investment options and strategies. However, IRAs restrict withdrawals, and taking money out before age 59½ can result in penalties.

For 2024, the maximum contribution amount the IRS will allow for IRAs is $7,000 (or $8,000 for those age 50 and older).³

Annuities

Annuities are insurance contracts that can offer guarantees and tax-deferred growth. While an annuity itself is not an investment, some annuities allow you to choose account options for investments inside of your contract. In exchange for a premium, an annuity may include an income guarantee that lasts as long as you're alive. Typically, these plans are best viewed as vehicles for long-term goals.

Annuity guarantees are backed by the insurance company you work with. Therefore, it's critical to use reputable, financially strong companies. Keep in mind that any withdrawals initiated before age 59½ may incur tax penalties, and you might need to keep funds in your contract for an extended period to maximize your benefits.

Ultimately, every investor may have unique circumstances, including different financial goals and tolerance for risk. Therefore, obtaining the guidance of a financial professional to choose appropriate types of investments can be a wise decision.

Sources

1. 10-Year US Market Annualized Excess Return. https://www.gurufocus.com/economic_indicators/4531/10year-us-market-annualized-excess-return.
2. Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits.
3. 401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000. https://www.irs.gov/newsroom/401k-limit-increases-to-23000-for-2024-ira-limit-rises-to-7000.