10 Different Types of Investments and How They Work

Investing can intimidate a lot of people because there are many options and it can be hard to figure out which investments are right for your portfolio.

This guide walks you through eleven of the most common types of investments, from stocks to commodities, and explains why you may want to consider including each in your portfolio. If you’re serious about investing, it might make sense to find a financial advisor who can guide you and help you figure out which investments will help you reach your goals.

What Are the 3 Main Investment Categories?

While the types of investments are numerous, it is possible to group them into one of three categories: equity, fixed-income and cash or cash equivalents. The term “equity” covers any kind of investment that gives the investor an ownership stake in an enterprise. The most common example is common stocks. Other examples are preferred shares, funds that hold stocks such as exchange-traded funds and mutual funds, private equity and American Depositary Receipts (ADRs). In 2022, global equity markets were valued at over $120 trillion.

Fixed-income investments provide investors with a stream of income, typically in the form of interest payments, over a set period of time. Bonds are the most well-known type of fixed-income security. The global bond market exceeded $128 trillion in 2022. Other fixed-income investments include certificates of deposit (CDs), money market accounts, and Treasury bills.

Cash and cash equivalents are the most liquid investments and can be quickly converted into cash with minimal impact on price. This category includes actual cash currency, checking accounts, savings accounts and money market funds. In the U.S., money market funds held over $4.7 trillion in assets as of January 2023.

1.Stocks

Stocks, also known as equities or shares, represent partial ownership in a company. When you buy a stock, you are purchasing a tiny slice of the company. Publicly traded companies issue stock so they can raise money from public investors.

How to make money: Stock investors make money in two main ways. First, if the price of the stock increases, you make money by selling it for more than you paid for it. Many stocks also pay dividends, which are regular distributions of a company’s earnings to investors. In 2022, S&P 500 companies paid out over $550 billion in dividends.

2. Bonds

When you buy a bond, you are loaning money to the issuer of the bond. In exchange, the issuer pays you interest on the loan and promises to pay back the loan’s principal at a specified time. Bonds are issued by corporations, the federal government, state and local governments, and government agencies.

How to make money: Bonds provide a steady stream of income through interest payments, which are made to bondholders typically every six months. The interest rate is determined at the time the bond is issued. When the bond matures, the original investment is repaid to the bondholder.

3. Mutual Funds

A mutual fund is a type of investment that pools money from many investors to purchase a diverse range of securities. Mutual funds are professionally managed according to the fund’s investment objective. They can invest in stocks, bonds, and other assets.

How to make money: When a mutual fund earns money through dividends or interest, it distributes a proportion of that to investors. When investments in the fund increase in value, the value of the fund increases as well, which means you could sell your mutual fund shares for a profit. In 2022, total net assets of U.S. mutual funds reached $23.9 trillion.

4. Exchange-Traded Funds (ETFs)

ETFs are similar to mutual funds in that they hold a basket of securities, but they trade on an exchange like a stock. ETFs often track a particular index, sector, commodity, or other asset. They tend to have lower fees than mutual funds.

How to make money: Like mutual funds, ETFs can make money through dividends and capital appreciation. The SPDR S&P 500 ETF (SPY), which tracks the S&P 500 index, had a total return of 28.7% in 2021.

5. Certificates of Deposit (CDs)

A CD is a low-risk investment offered by banks and credit unions. You deposit money for a specified period of time, and when the CD matures, you get your original principal back plus accrued interest. CDs typically offer higher interest rates than savings accounts.

How to make money: CDs earn a fixed interest rate over a set period of time, typically ranging from a few months to several years. Generally, the longer the term, the higher the interest rate. As of May 2023, the average 1-year CD rate was 1.36%.

6. Retirement Plans

Retirement plans aren’t a separate category of investment, per se, but a vehicle to buy stocks, bonds and funds in two tax-advantaged ways. The first lets you invest pretax dollars (as with a traditional IRA). The second allows you to withdraw money without paying taxes on that money (Roth IRA).

How to make money: The risks and returns for the investments in retirement plans are the same as if you were buying the investments outside of a retirement plan. However, retirement plans offer tax advantages that can boost your overall returns. As of the end of 2022, Americans held $11.7 trillion in IRAs and $7.5 trillion in 401(k) plans.

7. Options

An option is a contract that gives you the right, but not the obligation, to buy or sell an underlying asset at a set price on or before a certain date. Options can be used to hedge portfolio risk or speculate on price movements.

How to make money: If you buy a call option and the price of the underlying asset increases, you can exercise your option to buy at the lower price and then sell at the current higher market price. If you buy a put option and the price decreases, you can sell the asset at the higher exercise price. In 2022, options trading volume hit a record of over 10 billion contracts.

8. Annuities

An annuity is a contract between you and an insurance company. You make a lump sum payment or series of payments, and in return, the insurer agrees to make periodic payments to you, starting immediately or at some future point.

How to make money: Annuities can guarantee an additional stream of income for retirement. But while they are fairly low risk, they aren’t high-growth. So investors tend to use them as a supplement to their retirement savings, rather than an integral source of funding.

9. Commodities

Commodities are raw materials used to create products. They include energy sources like oil and gas, precious metals like gold and silver, industrial metals, and agricultural products.

How to make money: Investors can profit from commodities by buying them directly, buying futures contracts, or investing in exchange-traded funds (ETFs) that track commodity prices. Commodities can be volatile but may provide a hedge against inflation. In 2022, commodity ETFs saw record inflows of nearly $20 billion.

10. Real Estate

Real estate is property comprised of land and the buildings on it. Real estate investments can be made by purchasing property directly or by investing in securities that provide real estate exposure, such as REITs.

How to make money: Real estate investors make money through collecting rents (income), through capital appreciation as property values increase over time, or both. Real estate has historically been a good hedge against inflation. As of April 2023, the median existing-home sales price in the U.S. was $388,800, up 1.5% from a year earlier.

There are a lot of different types of investments to choose from. Some are perfect for beginners, while others require more experience and research. Each type of investment offers a different level of risk and reward, giving you a good option or two no matter what your investment goals are.

The key is to understand your investment objectives, risk tolerance, and time horizon. This will help guide you to the types of investments that are most suitable for your individual circumstances. As always, it’s wise to diversify your portfolio across different asset classes to manage risk while still providing opportunities for growth.

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