Investing can be overwhelming for many people due to the abundance of options available, making it difficult to decide which investments are appropriate for their portfolio. This guide simplifies the process by presenting five common investment types, including stocks, mutual funds, certificates of deposit (CDs), options, and derivatives, and explains why each may be a valuable addition to one’s portfolio.
Stocks are perhaps the most well-known and straightforward type of investment. When purchasing stock, you buy an ownership stake in a publicly-traded company, with some of the country’s largest corporations, such as Exxon, Apple, and Microsoft, being publicly traded. Investors hope to make a profit by selling the stock when its price increases, although they risk losing money if the stock’s price declines.
Mutual funds, on the other hand, involve a pool of investments from multiple investors that is invested broadly across several companies. Mutual funds can be actively or passively managed, with the former involving a fund manager selecting securities that will outperform a designated market index, and the latter tracking a major stock market index, such as the Dow Jones Industrial Average or the S&P 500. Mutual funds can invest in various securities, such as equities, bonds, commodities, currencies, and derivatives. Although mutual funds carry similar risks to stocks and bonds, the risk is typically lower because the investments are inherently diversified.
Certificates of deposit (CDs) are low-risk investments that involve giving a bank a specified amount of money for a predetermined period and earning interest on that money. Once the term ends, investors receive their principal and the predetermined amount of interest. CDs are FDIC-insured up to $250,000, making them a good long-term investment for saving money, but investors must be cautious about early withdrawals, which incur significant penalties.
Options and derivatives are more advanced investment types that require a greater degree of expertise. Options provide investors with the opportunity to purchase or sell an asset at a specific price and time, with call options allowing for the purchase of an asset and put options allowing for its sale. Derivatives, on the other hand, derive their value from another asset, with the contract being an agreement to sell the asset at a specific price in the future. Futures contracts, swaps, and options contracts are the three most common types of derivatives.
Investors can make money with options and derivatives by correctly predicting price fluctuations, although these investment types are not recommended for retail investors without significant expertise.
Ultimately, finding a qualified financial advisor can be beneficial when investing, and SmartAsset’s free tool matches investors with up to three vetted financial advisors in their area, enabling them to interview their advisor matches at no cost and choose the one that is most suitable for them.