According to the 2019 Schwab Modern Wealth Survey, Americans believe someone to be “wealthy” if they have at least $2.3 million in net worth. Arguably, the best approach to building wealth is to invest and watch your money multiply.
Before you start investing, though, you must understand the different types of investment vehicles, and how they work to appreciate your money.
What Is an Investment Vehicle?
In order to put your money towards an investment, you will need a “vehicle,” or a means of getting it there. Investment vehicles are just that– they give investors the ability to invest and watch their money grow.
There are several different investment vehicles individuals can choose from, including:
- Stocks (equity)
- Mutual Funds
- Exchange-Traded Funds (ETF)
- Real Estate
Each of these vehicles varies in terms of the amount of risk associated with it. Typically, the higher the risk, the higher the potential return can be.
Now, let’s take a look at how each one works.
What Are Stocks?
The first investment vehicle, stocks, are a form of equity. They represent ownership of a particular company. Investors can buy and sell shares of stock on an exchange such as the New York Stock Exchange (NYSE) or Nasdaq.
Stocks are among the most common types of investments because of the liquidity and historic returns the stock market has produced. Companies will issue stock when raising funds for the company to continue operations, fund projects, or if they are in need.
Individuals who own stock are referred to as shareholders. Shareholders are given the ability to vote in shareholder meetings and receive dividends. Dividends are a share of the company’s earnings that are paid out to shareholders, typically on either an annual or quarterly basis.
Collecting dividends and reinvesting has been one of the most effective approaches to building wealth. In fact, according to a study from Hartford Funds, it accounts for 78 percent of the total returns from the S&P 500. Reinvesting dividends gives investors an ability to begin collecting compound interest (the amount of money you earn from interest on top of your initial investment).
Risk Level: Stocks come with a varying amount of risk, depending on which companies you are investing in, as well as the state of the economy, politics, etc.
What Are Bonds?
Stocks and bonds often get talked about together, but are really two completely different investment vehicles. Companies will issue bonds when they are raising money to fund projects and other operations. Bonds are a form of debt that is loaned to investors, and in return, investors receive a fixed payment for holding.
Interest rates heavily influence the price of bonds. If interest rates are high, bond prices will decline, and the opposite is true as well. Governments and corporations can issue bonds to raise funds.
The borrower will set the terms for the bond, including the interest payments that will be made and the date the principal is due.
Risk Level: Bonds are often seen as less risky than stocks because stocks must gain value over time, where bonds pay a fixed amount.
What Are Commodities?
Commodities are assets or goods that can be bought and sold. Investors will commonly purchase commodities to either hedge their positions or as speculation.
Commodities are commonly divided into four categories:
- Precious Metals
Precious metals, including gold, and silver, are frequently bought by investors when they are worried stock prices may decline, as they usually experience an inverse relationship. When it comes to energy, investors will speculate on the prices of things like natural gas and oil.
Risk Level: Commodities can be risky to invest in, as they are subject to price changes based on factors that require a great deal of attention.
What Are Mutual Funds?
Mutual funds allow investors to pool their money together. This gives them the ability to invest in stocks, bonds, and commodities that they might not have been able to otherwise. Unlike stocks, when you own a share in a mutual fund, you are invested in many stocks (or securities), not just one.
The value of a mutual fund is determined by the performance of the investments held in that fund. Professional money managers will distribute and assign resources accordingly to produce returns for investors.
Mutual funds charge annual fees, and sometimes commissions, which can affect their overall returns.
Risk Level: Mutual funds are some of the least risky investments, due to the diversification of the portfolio.
What Are ETFs?
Exchange-traded funds (ETFs) are similar to mutual funds, in that the securities are diverse. However, unlike mutual funds, ETF shares trade on the open market and can be bought and sold during market hours.
ETFs can track indexes and consist of all different types of securities like stocks, bonds, and commodities. ETFs are an excellent choice for those looking to passively invest, or who don’t have the time to invest in single stocks.
Risk Level: These types of funds are considered less risky because of the diversification and liquidity associated with them. One of the most recognized ETFs, the SPYDER S&P 500 (SPY), is used to track the S&P 500 index movement.
What Is Cash?
Cash and cash equivalents can also be considered an investment because of the interest accrued. Cash equivalents can include savings accounts and other bank accounts.
Risk Level: Cash is the least risky of the investments because of its stability. However, investors won’t be earning any considerable returns just sitting on cash. Usually, investors will take a cash position when other financial markets look unstable, to protect their earnings.
What Is Real Estate?
Some people might categorize real estate as an asset class, not an investment vehicle, but I consider it one. It is a way to directly invest and grow your money.
Real estate consistently increases in value overtime, and outperforms other investments. Although not all real estate investments are good ones.
You can invest in real estate by purchasing your own home, rental properties, house flipping, wholesaling, syndication, crowdfunding, or REITs.
Risk Level: The risk is medium, depending on what type of investment you make, and how well you’ve vetted the real estate. It could be a higher risk for newbie investors with little knowledge.
If you are new to real estate investing, study up! Make sure you read Real Estate Strategy 101: Learn the Basics, the Lingo, and the Opportunities.
Which Investment Vehicles Carry the Least Risk?
When it comes to investment vehicles, generally, it’s assumed that the lower the risk, the lower the potential return. So cash and cash equivalents will be the least risky of the investments, but will also often produce the least amount of returns.
Mutual funds and ETFs are a great option for diversifying your portfolio and give you the ability to invest in several different assets. When it comes to stocks, the specific company you invest in will determine the amount of risk you inherit. Keep in mind that financial markets are subject to risks that are sometimes hard to account for.