Money 101

Lesson 4: Types of Investments

Types of Investments

There are two basic ways to invest: You can be an owner or a lender. The two most common types of investments are stocks and bonds. When you buy a company’s stock, you become an owner of that company, even if you only own a miniscule stake. When you buy a company’s bonds, you become a lender to that company.

Stocks

These are ownership stakes issued by companies. Stocks never expire, and they don’t pay an interest rate. That means when you buy a stock, you don’t know how much you’ll ultimately earn, and you’ll generally hold it as long as you want to. The price you pay when you buy a stock—and the price you would receive if you were to sell it—are determined by the stock market. Stock prices can bounce around a lot in the short term. But in the big picture, investing in stocks is a winning strategy: Over the long term, stocks have returned about 10% annually on average.

Bonds

These are debts issued by companies or governments. Unlike stocks, when you buy a bond, you know exactly how much you are likely to make since most bonds pay a fixed interest rate and mature on a certain date. Because of that relative certainty and because bond prices are more stable than stock prices, bonds are considered to be safer investments than stocks. (Sometimes companies or governments don’t repay their debts, but those occasions are the exceptions.) However, they also offer lower returns. Over the long term, bonds have returned about 5% annually on average.

Investing is powerful because it can grow your money faster than savings-type vehicles.

If you put $10,000 today into a savings account that pays 1%, you would have $11,046 at the end of ten years. But invest that same amount in a group of stocks that return 10% annually on average and you would have $25,937 at the end of the ten years. 

However, investing always comes with risk, and being a successful investor means understanding and managing risk. Generally, for longer-term goals, you should invest in riskier options, which typically return more. For shorter-term goals, take on less risk.

Fun Facts:

  • A Hermes Birkin bag has returned 14% per year on average compared with the S&P’s 10% average.
  • Laszlo Hanyecz, a programmer, paid 10,000 Bitcoins (roughly $25) for two Papa John’s pizzas on May 22, 2010. He did not know that it would be worth around $150 million today. Since then, May 22 is celebrated as Bitcoin Pizza Day to celebrate the most expensive pizzas in history.

Types of investments in order of risk