You have decided to invest. You have the drive and the money, but one key thing is missing—you don’t know what type of investment suits you. Luckily you’ve landed at just the right place as I will help you decipher different types of investments and guide you towards making a great investment decision.
There is no single best type of investment. You ultimately need to weigh up your end goal and pick an investment that will accommodate this goal. Passive income may require dividend stocks, capital appreciation suggests growth stocks and, both capital appreciation and passive income may hint towards property.
Are you ready to learn the ins and outs of investing? Let’s dive together into the pool of investment types. Once you read through the post, you’ll be a real investing know-it-all that will have no trouble deciding what route you need to take.
First Steps of Investing—Where to Start From?
When you strip down the complexities of investing, the beginning of your investment endeavours starts with your goals. The risk, the return, and the time you need to wait to reap the fruits of your thought-out choice all depend on your reasons for investing.
Some of the common investing motivators are:
- Returning a loan;
- Going on a dream holiday;
- Growing funds for a business;
- Buying a property;
- Saving for children’s university; and
- Saving for retirement.
What you can notice is that certain goals ask for quick returns while others leave you time to slowly grow your funds. Not all investment types are suitable for holding your assets short-term. If you sell out too early, your investment will face risks such as losing its purchasing power.
A bad choice of investment can also leave you with an investment that can’t be liquidated when you need it. An example of this is investing in property that can’t be sold quickly at a fair price.
So, before you start diligently studying the types of investments, clarify what is your goal and how much time you have to spare to let your investments “cook.”
Understanding the Risk to Return Ratio
Can we even talk about investing without mentioning the risk? Of course not. Besides defining your goal, you need to align your investments with the risk you are ready to undertake.
Most commonly, the level of risk corresponds with the upside potential. Expecting the highest return with minimal risk is as unlikely as expecting to win the lottery without buying a ticket. However, low-risk investments can lead you to a desirable return. However, you need to have patience and be ready to let your investment rest and accumulate money.
Now, let’s segment types of investments according to the risk and return they come with. If you only want to focus on low-risk investments, for example, you can use this table to pinpoint the investment options you should consider.
| Low Risk/Return Investments | Medium Risk/Return Investments | High Risk/Return Investments |
|---|---|---|
| – High-yield savings accounts; – Savings bonds; – Certificates of deposit (COD); – Government bonds; and – Exchange-traded funds. | – Utility stocks; – Mutual funds; – Corporate bonds; – Dividend-paying stocks; and – Real estate investment trusts (REITs). | – Individual stocks; – High-yield bonds; and – Venture capital trusts (VCTs) |
High-risk investments aren’t for everyone. They should be approached with caution, but they can be a good opportunity for experienced investors with an existing investing portfolio. The tricks they’ve learned combined with the safety net in the form of other investments can make investments with high return potential, a promising choice.
Various types of risks lurk over the investments, such as:
- Interest rate risk;
- Purchasing power risk;
- Reinvestment risk;
- Liquidity risk;
- Inflation risk; and
- Market risk.
How should you know which risk proposes a threat to your preferred investment? Just follow these guidelines:
| FIXED INCOME INVESTMENTS | EQUITY-BASED INVESTMENTS |
|---|---|
| INTEREST RATE RISK PURCHASING POWER RISK REINVESTMENT RISK LIQUIDITY RISK INFLATION RISK | MARKET RISK |
Fixed Income Investments are essentially referring to Bonds and Certificates of Deposit – I’ve got an article all about Fixed Income Investments called ‘Bonds: Why Are They Called Fixed Income‘ which goes into these in greater detail.
However, don’t let the number of risks that tag along with fixed income investment fool you. Equity-based investments aren’t less risky. Changes in the market happens more often than inflation or drastic interest rate changes.
What you must keep in mind is that there is no investment with absolutely no risk. Every time you invest money you need to be aware of the liabilities. Again, I’ve got another article around the best way to reduce investment risk called ‘Investing: Which Investments Don’t Lose You Money?‘ so definitely give that a read!
Types of Investments—Breaking It Down Into Pieces
Now it is time for the climax of the story—the types of investments. We’ll start from the low-risk investments and progress our way to the high-risk investments that all you daredevils out there want to know about.
Note that all these types of investments come with their benefits and drawbacks. You need to analyse them objectively before you make the final judgement.
1. High-interest savings accounts (Fixed Term Deposits)
- Level of risk: Low
- Best for: Beginner investors that want to avoid risk and grow their funds. They are also a fitting choice for those who aim for short-term investments.
High-interest savings accounts will help you break the barrier of passively saving your money on the account. They will help you accumulate additional pounds in the form of interest while your deposit safely sits in a bank.
When choosing a savings account you want to aim for high interest and the time period that aligns with your needs. So, if you want to let the money increase for 5 years, you can choose a set period that often comes with higher interest as a reward.
| Benefits | Drawbacks |
| – One of the safest forms of investing; and – Not much research needed. | – Limited withdrawals; and – Minimum deposit required. |
2. Savings bonds
- Level of risk: Low
- Best for: Investors that don’t mind waiting and who want to make a stable investment.
Imagine that you get to lend a bank some money. You can move that scenario from imagination to reality, as savings bonds are exactly that—your loan to a bank, building societies, or National Savings and Investments (NS&I).
If you invest in savings bonds, you provide the bond issuer (for example, a bank) a fixed amount of funds for a set period. In return, the issuer gives you an interest rate that is higher than what you’ll get with deposit accounts.
You can choose between:
- Fixed-rate savings bonds – You get a set interest over a specific time.
- Tracker bonds – A fixed-term investment where a part of your money is in a deposit based account and another part is invested in the stock market.
Typically, the minimum deposit is £1,000 or £2,000.
| Benefits | Drawbacks |
| – Minimal (or non-existent) risk; and – Higher return than a savings account. | – Lack of liquidity; and – You can draw the capital only at the end of the term. |
3. Certificates of deposit (CODs)
- Level of risk: Low
- Best for: Investors with long-term goals that are ready to tie their money down.
Certificates of deposit or CODs are certificates issued by a bank which serve as proof that you lent the bank a certain amount of money. Based on the terms of use of CODs, the bank needs to pay you interest.
If you invest in CODs, be ready to forget about that money for that set period. If you withdraw the funds ahead of time you will need to pay a financial penalty fee.
Why people go for CODs instead of savings accounts? Because they usually come with a higher interest rate. That is, they are a more profitable form of investing.
This type of investments can be perfect for those who are saving for retirement or purchasing a home in 5-10 years. The longer you wait, your accumulated interest will grow. After the “deadline”, you can end up with a pretty decent amount of money.
Make sure that you do your research before you invest in a COD. Taking your time to dig out the best-paying COD can bring you a much higher return.
| Benefits | Drawbacks |
| – Very safe investment; and – A higher interest rate compared to savings accounts. | – Lack of liquidity; and – The financial penalty fee for withdrawing funds. |
4. Government bonds
- Level of risk: Low
- Best for: Risk-averse oriented investors who are searching for a long-term investment.
Government bonds, also known as gilts, present a loan that a bondholder (you) has given to the government. So, when the government needs money, they issue bonds.
This is a win-win solution, as the government gets funds they can dispose of for government purposes why you get an interest rate for being so generous to make the loan.
The bond has a fixed term that can vary from 5 to 30 years. Your money is tied to the bond for that set time. After it expires, you will receive the initial capital along with the accumulated interest.
| Benefits | Drawbacks |
| – Secure investment; and – Tax-free. | – Low return potential; and – They can lose purchasing power due to inflation. |
5. Exchange-traded funds (ETFs)
- Level of risk: Low-Medium
- Best for: Thriving investors who want to get more familiar with the variety of securities without increasing the level of risk.
ETFs present a collection of assets such as stocks, bonds, or other securities that are traded as a single unified stock. Having a group of diversified securities comes with lower risk because the outcome of your investments doesn’t depend on how a single asset will perform.
With ETFs, you get to create your portfolio of securities that you want to invest in. You can create the portfolio yourself, or hire a financial advisor to help you out.
This type of investment can open up the doors to international markets. Just track the most promising stock and/or bonds in the world, put them together in your portfolio, and let them earn you money. The world is your oyster, as some would say.
You’ll have complete security with ETFs as you can track the performance of each asset. There’s also the fact that ETFs are passive investments that don’t demand that you keep an eye on a market index. You are free to buy and sell them like bonds or stocks.
| Benefits | Drawbacks |
| – Diversified investment; and – Lower cost compared to other investment funds. | – Demands some investment skills; and – The income is not fixed (nor guaranteed). |
6. Utility stocks
- Level of risk: Medium
- Best for: Ambitious investors who want a safe but more profitable investment.
Utility stocks do come with some risk but they also bring to the table, the potential of a higher return. The need for energy, electricity, and water can hardly be in decline which means a higher dividend for you.
If you buy utility stocks, you’ll be purchasing stock from a utility company. The company in which you decide to invest in will pay you a dividend.
Why utility stocks? Well, unlike other sectors, utility companies tend to offer more security. They are less likely to fall under unpredictable market risk.
The companies you can look into for investing in their stocks are:
- Energy networks, wastewater networks or sewage works maintenance companies;
- Companies that produce and supply energy; and/or
- Energy network operating companies.
The company can focus on a single sector mentioned above or it can embody all utility-related services.
You should do thorough research on the company’s performance and history before you make your investment. But if you need some nudge, some utility companies you should keep an eye on are:
| Benefits | Drawbacks |
| – Higher dividend; and – Predictable profitability. | – Demands research and strategic investing; and – Economic uncertainty can lead to a decrease in value. |
7. Mutual funds
- Level of risk: Medium
- Best for: Investors who don’t mind some risk and who want higher return over a longer period of time.
If you are an ‘open-to-different-possibilities’ type of person, you can find what you’ve been looking for in mutual funds.
Mutual funds are managed by professionals who have the expertise and skills needed to effectively buy, monitor, and sell investments. All their effort is aimed at growing your money.
Investors (this can be you) put their money in these funds, which will be scattered across different securities. The diversification lessens the risk, as if one asset underperforms, you’ll have others to rely on.
You might notice the similarity with ETFs which are also diversified securities, and you are right, the similarity exists—but so does the difference. Unlike ETFs which are passive investments, mutual funds are actively managed.
Some funds focus their investments on a certain niche, such as creating a portfolio of securities from companies in the biotech industry.
| Benefits | Drawbacks |
| – Funds managed by experts; and – Diversification of securities. | – Prepare to invest for 5+ years; and – Industry focused funds are exposed to industry-specific risk. |
8. Corporate bonds
- Level of risk: Medium
- Best for: Investors with some affinity to risk that want a higher potential for growth.
Corporate bonds are in fact a company’s debt that you are willing to buy off if the company pays you yearly interest over a set period. When the life of the bond ends, you will get a fixed payment for your kind investment.
You can find corporate bonds on a stock exchange and their price is affected by the demand and supply.
How did corporate bonds find themselves in the middle of the risk scale? Well, they carry more risk than government bonds as you buy off a company’s debt. On the other hand, they aren’t as risky as equities because you get your annual payments without exception.
To keep your corporate bond investment on the safer side look for bonds with a triple-A (AAA) rating.
| Benefits | Drawbacks |
| – A higher return potential; and – Possibility to buy bonds with minor risk. | – Higher risk than government bonds; and – Their value may fall due to a rise in interest rate, inflation, or economic downturn. |
9. Dividend-paying stocks
- Level of risk: Medium
- Best for: Investors who want to combine a fixed income with the possibility of stocks’ growth
When a company issues dividend-paying stocks, they allow investors to become stakeholders in their company. Besides the potential that the stock’s worth will grow (along with their investment), the stakeholders also get regular income in the form of dividends.
To invest in the right dividend-paying stock, you need to research the company’s history regarding its consistency in paying dividends as well their market performance. If you come across a growth-stage company with a moderate share price, that’s when you should step in.
| Benefits | Drawbacks |
| – A regular stream of income; and – Capital preservation. | – The company can stop paying dividends if they don’t make a profit; and – If the business becomes insolvent, you lose your money. |
10. Real estate investment trusts (REITs)
- Level of risk: Medium-High
- Best for: Investors who wish to put their money in real estate without dealing with tenants and maintenance.
REITs are operating with real-estate-related assets and they let investors buy a portion of their units. For example, a REIT company owns and operates commercial properties. You can invest your money in that portfolio and collect income from the generated profit.
It’s somewhat like receiving rent with non-existing tenants. That rent takes the shape of dividends that the property investment company pays. The dividend is most often paid quarterly.
The portfolio doesn’t need to be limited to the UK real estate market or a specific type of real estate. You can choose a portfolio of a variety of commercial, residential, and industrial properties.
If you have a high interest in investing in REITs, but not an equally high desire to research your best options, better get a financial advisor on board.
| Benefits | Drawbacks |
| – A good way to diversify your investment portfolio; and – Consistent income. | – REITs pay property taxes; and – As equities, they are at risk of market change and property demand. |
11. Individual stocks
- Level of risk: High
- Best for: Investors with an existing portfolio of investments who are looking for diversification with a potential of high return.
If you buy an individual stock you are buying a part ownership in a single company. Let me paint this picture with an example. You come across a company that sells electric cars and they have issued stocks. This seems to you like a promising company and you buy a share in their ownership. Now you’ve got yourself an individual stock.
Individual stocks are high risk because you put your faith and money in one company. If the company goes down, so will your investment capital. However, if the company grows and becomes a true success, your investment can pay off big time.
For anyone who is tempted by individual stocks, try to keep your stock holdings no more than 10% of your portfolio.
| Benefits | Drawbacks |
| – The big potential of return; and – Diversifying an existing investment portfolio | – High level of volatility; and – No fixed income |
12. High-yield bonds
- Level of risk: High
- Best for: Experienced investors who can recognise when growth trends are favourable and who want a high return for their investments.
High yield bonds are commonly known as junk bonds, which already reveals that their credit rating isn’t the best one. These bonds are rated BB, B, CCC, CC or C which represent low rating.
Since the bonds carry more risk, the bondholders will receive a higher level of interest compared to bonds with a better rating. The companies are willing to pay more to anyone ready to risk it.
These types of bonds shouldn’t be reserved for big investments as there is a high chance that you will lose the money. If you have dabbled in the investment market for some time and you know how to responsibly approach high-risk investments, that’s when investing in high-yield bonds can be a good strategic decision.
| Benefits | Drawbacks |
| – High payout; and – If the company fails, bondholders get paid out before the shareholders. | – High risk of losing the investment; – The value of a bond is affected by the change in the interest rate and the drop in the issuer’s credit ranking. |
13. Venture capital trusts (VCTs)
- Level of risk: High
- Best for: Talented and experienced investors who are good at spotting promising start-up funds.
Venture capital trusts (VCTs) are companies that recognise up-and-coming companies with growth potential and invest in them. These small companies or start-ups need funds for growing their business, while VCTs have an opportunity to buy shares for less money which can eventually bring enormous profit if the innovative businesses succeed.
If you want to invest in a VCT you should follow 3 rules:
- Consider getting advice from an experienced VCT investor;
- Invest only long-term (5 years minimum); and
- Understand and accept the risk.
Since you invest in the state’s growing economy with your VCT investment, there is tax relief on these types of investments.
| Benefits | Drawbacks |
| – Potential for high return; and – Tax relief. | – No extensive history of the company to assess the risk; and – Bonds can be harder to sell. |
Choose Wisely, Carefully, and Strategically—That’s How You’ll Make the Right Pick
This brings us to the end of our exciting journey. Hopefully, the extensive guide has clarified what different investments bring. For your money’s sake, always consider your goals, your timeline, and risk tolerance before you make an investment decision. Also, back that up with thorough research and advice from a professional. If you get that covered, you won’t need the luck to make the right profitable investment.