Understanding different types of investments: Stocks, bonds, mutual funds, ETFs

In your daily life, there are several things crucial to your physical well-being. One such thing is a habit of consuming two or three balanced and timely meals every day. Similarly, when it comes to maintaining your financial health, there is one essential action you must carry out — investing. 

Take a minute to think about your diet. It consists of different food groups and meal combinations tailored to your preferences and health requirements, doesn’t it? Likewise, the investments you choose should align with your unique financial profile and goals. Just as a balanced diet promotes overall wellness, selecting the right types of investments in the right proportions will help you enjoy financial health.

Table of contents

1. What is investing and why is it important?

2. Why is investing better than saving?

3. Things to keep in mind when investing

4. Different types of investments

5. Stocks

6. Bonds

7. Mutual funds

8. Exchange-traded funds

9. How to invest in different types of investments conveniently?

10. Frequently asked questions

1. What is investing, and why is it important?

When you put your money into an asset or project with the intention of earning an income or generating a profit over time, what you’re doing is investing. Stocks, bonds, mutual funds, and exchange-traded funds (ETFs) are among the more popular investment options, and tend to make up a large proportion of most retail investors’ portfolios. 

There are several important reasons why you should invest. First, investing helps you beat inflation. Due to inflation, the value of your money gets eroded over time. But if you invest your surplus funds in securities such as stocks that can generate inflation-beating returns, you can preserve the value of your money over time. 

Second, investing allows you to build wealth over the long term through the power of compounding and capital appreciation. Third, investing helps you meet various short-, medium-, and long-term financial goals, such as buying a car, funding your higher education, and saving for retirement.

2. Why is investing better than saving?

Investing is a powerful tool to preserve and grow the value of your hard-earned money. It’s different from saving in that it provides the opportunity to earn returns, which comes with an element of risk. 

When you save money, you’re simply setting aside a part of your income to be used for a goal some time in the future: there’s no expectation of getting more money out than you put in. But when you invest, that’s exactly what you’re looking for: more money than what you began with. Such an outcome, however, is not always guaranteed, which is why investing carries a certain level of risk. 

When you merely save money, you’re not using your funds to their full potential, and are allowing their value to reduce over time due to inflation. Hence, investing is better than saving because it puts your money to work for you and helps you build wealth over time.

There are several asset classes you can invest in, with each requiring different strategies for achieving an optimal outcome. For instance, you could decide to invest in a large-cap equity mutual fund through a five-year Systematic Investment Plan (SIP) in order to fund your dream honeymoon. Or you could directly invest in large-cap stocks for a longer duration with the intention of earning dividend income regularly. 

Does this sound a bit complicated? Well, let’s break this down into two parts — all the things to keep in mind when investing and understanding the different types of investments out there. 

3. Things to keep in mind when investing 

When you want to begin investing, there are a few factors that you need to consider and be aware of. These include:

3.1 Investment objective

One of the first things you need to ask yourself is why you want to invest. Is it because you want to earn some regular passive income? Is it because you want to save for a long-term goal like buying a house? Whatever your answer is, it will help guide you regarding the type of investment instruments you should pick. For earning a passive income, for instance, fixed-income securities like bonds are a good option. 

3.2 Investment horizon

The next thing you need to consider is how long you are planning to keep your money invested. If you have a long-term investment horizon, say five years and above, then investing in stocks is a wise idea. That’s because the stock market is relatively volatile over the short- and medium-term. So for shorter investment horizons, you need to invest in securities with lower capital risk. 

3.3 Risk-return profile 

Different types of investments come with different risk-return profiles, and you need to study them before getting started with investing. As a general rule, the higher the risk, the higher the possible returns from a specific investment. Here, you also need to consider your own risk appetite, which is your individual capacity and willingness to take investment risks in order to earn higher returns. 

3.4 Costs and expenses 

It’s essential to consider the costs and expenses involved in investing, as that has a direct impact on your returns. For instance, when you invest in mutual funds, there is a fee levied for the professional fund management services provided, called the expense ratio. The higher the expense ratio, the more it will eat into your returns. 

3.5 Liquidity and lock-in periods 

Liquidity refers to the ease and speed with which you can convert your investment back into cash. Some investments, such as tax-saving instruments like Public Provident Funds (PPFs), come with a lock-in period. A lock-in period is a mandatory investment horizon for an investment during which you cannot sell it. Hence, you need to consider how liquid the asset you’re investing in is and how important liquidity is for you. 

3.6 Taxation 

Whenever you earn any type of income, the government levies taxes on it, and investment income is no different. There are two main types of taxes applicable to investment income — capital gains tax and tax on dividend and interest income. The tax rate and other terms are specific to the type of investment, the investment horizon, and the amount of investment income. Hence, you need to carefully consider the tax implications for the investment product you are selecting. 

Now that we’ve seen the key factors to keep in mind before getting started with investing, let’s understand the different types of investments available to us. 

4. Different types of investments 

As an investor, you are spoilt for choice. There are many investment options out there — stocks, real estate, bonds, mutual funds, ETFs, art and other collectibles, venture capital, private equity, retirement accounts, cryptocurrency, commodities, and more. 

Of these types of investments, there are four avenues that are highly sought after and relatively easily accessible to the average individual investor. These are stocks, bonds, mutual funds, and ETFs. And it’s these four that we are going to explore in depth in this blog. 

5. Stocks 

When you invest in the stock of a company, you essentially get an equity stake in that company and can benefit from the company’s growth and performance. 

5.1 Features of stock investments 

Stocks are known for yielding some of the highest returns compared to other investment options, and have a significant potential for capital appreciation. Certain stock investments can also provide passive income in the form of dividends. 

However, stocks also carry a high level of risk because of relatively high market volatility — constant price fluctuations that are largely unpredictable. A range of macro- and micro-economic factors can cause the price of a stock to increase or decrease. For instance, if a company’s CEO gets involved in a scandal, that can lead to the company’s stock plunging. 

5.2 Returns 

Stocks have excellent return potential. Stock returns also have great potential to be inflation-beating, which means you can use them to preserve the value of your money over time. The average stock market return in the US, as measured by the S&P 500 benchmark index, has been around 10% per year over roughly the last century.

5.3 Who should invest in stocks?

Stocks are best suited for those investors who have a high risk appetite. That’s because the volatility of the stock market is a double-edged sword — if prices rise, then you can earn significant capital gains but if they plunge, you can lose a large chunk of your money. You should also have a long investment horizon, as that reduces the impact of short-term market fluctuations.

In addition to this, you also need to be actively involved in researching and analysing companies — their financials and quarterly results, business plans, mergers, etc. It’s essential for those investing in stocks directly to have the time to stay updated with market trends and have the knowledge to mitigate risk through diversification. 

6. Bonds 

Bonds are issued by governments and companies when they want to raise funds in the form of debt. They come with a fixed tenure and a rate of interest like any other debt obligation. You can buy them in the primary market at the time of their issue or in the secondary market from other investors. 

6.1 Features of bonds

Bonds are fixed-income instruments, which means that they provide interest income over their specified tenure. This interest is predetermined and certain. So, if you hold bonds until maturity, you can get regular interest income from them. Alternatively, you can also sell your bond investments in the secondary market before maturity at a higher price to earn capital gains.  

Bonds are generally considered to be low-risk investments, especially compared to stocks. This is because they provide a higher level of capital preservation, as the bond market lacks the inherent volatility that comes with the stock market. Bonds do carry credit and interest rate risks, but those can be lowered depending on the type of bond you invest in. For instance, government bonds like treasury bills or T-bills carry minimal to zero credit risk as they are backed by sovereign guarantee. 

6.2 Returns

Bonds tend to generate lower returns compared to stocks but they also carry a lower level of risk. On average, over about the last century, bonds have returned between 4% and 6% a year in the US. 

The kinds of returns you can earn from bonds also depends on the type of bonds you invest in. Typically, corporate bonds provide higher returns compared to government bonds since they carry a higher level of credit risk. Similarly, bonds with low credit ratings tend to have higher interest rates to compensate for the higher level of risk. 

6.3 Who should invest in bonds?

Bond investments are suitable for investors who have a low risk appetite and are looking for stable income. These investments are also suited for those with a relatively short investment horizon. For instance, someone close to retirement is usually advised to increase their exposure to bonds over stocks. 

Bonds are essentially ideal for capital preservation rather than capital appreciation. When you want to protect the wealth you already have while earning some returns on it, you should consider bonds. 

7. Mutual funds

Mutual funds are an investment product that pool money from multiple investors and then allocate it to various assets to build a portfolio that is aligned with the fund’s investment objectives and risk level. 

7.1 Features of mutual funds 

Mutual fund investments are great for diversification since they don’t just invest in a single security. For instance, an equity mutual fund will invest in stocks of multiple companies in a way that attempts to lower risk and improve returns. 

Another feature of mutual funds is that they offer professional fund management. Behind each mutual fund is an experienced team of fund managers who decide what to buy, when to buy, when to sell, etc. Mutual funds also offer a wide variety of schemes to invest in: large-cap funds, index funds, bond funds, gold funds, etc.

7.2 Returns

The returns of a mutual fund investment depend on factors such as the fund’s type, investment strategy, management expertise, asset allocation, and expense ratio. For instance, an index fund simply aims to mimic the returns of its benchmark index and doesn’t try to outperform it.

Before investing in a mutual fund, you should assess its performance over the past one, three, and five years to understand if it’s a good option. You should also look at the fund’s performance in comparison to benchmark indexes and its peer funds, as well as ratios such as alpha, beta, and standard deviation. 

7.3 Who should invest in mutual funds?

Mutual funds are a great choice for new investors who do not have sufficient knowledge to invest directly in instruments like stocks and bonds, as mutual funds are professionally managed. Professional fund management isn’t just beneficial for new investors but also for experienced ones who do not have the time to actively manage their investments.

They are also a great choice for investors seeking diversification. Mutual fund schemes are often designed with diversification in mind so that even if one of its holdings takes a hit, the overall returns of the fund won’t be affected drastically. 

8. Exchange-traded funds

Exchange-traded funds are similar to mutual funds in that they typically offer inherent diversification and invest in a basket of securities. But, like stocks, ETFs can be bought and sold on stock exchanges. They are usually designed to track a specific market index, sector, commodity, or asset. 

8.1 Features of ETFs

ETFs also have fund managers who create and maintain a portfolio of securities to generate high returns in line with the investment objective. They offer high diversification, liquidity, and transparency to investors. 

ETF investments are often passively managed, which means that they track an index or asset in order to mirror its performance rather than beating it. Due to this, ETFs usually have lower expense ratios than actively managed mutual funds. 

8.2 Returns 

As is the case with mutual funds, the returns on ETF investments depend on a range of factors, such as the specific ETF type selected, the benchmark index it’s tracking, the fund management style, the portfolio composition, and the expense ratio. 

Since ETFs are market-linked instruments, they do tend to provide higher returns than debt instruments like bonds. 

8.3 Who should invest in ETFs?

Investors who are looking for a low-cost way of investing in the broader market over the long term can invest in ETFs. It’s a convenient and cost-effective way to add diversification to your portfolio.

Additionally, if you are looking to gain exposure to specific sectors for adopting a sector rotation strategy, you can invest in sector-specific ETFs like tech ETFs

9. How to invest in different types of investments conveniently?

For a well-diversified portfolio, it’s important to invest in multiple types of securities instead of only sticking to one asset class or product type. The ideal asset allocation between stocks, bonds, mutual funds, and ETFs will depend on your financial goals, risk appetite, and investment horizon. 

It’s important to invest through a platform that provides you with access to different types of investments, both in the domestic and international markets, in an easy and cost-effective way. And that’s exactly what Appreciate offers! With the Appreciate app, you can seamlessly access top-performing US securities through just a few taps on your phone. With tools like Change Savings, AI-based recommendations, and systematic investment plans, Appreciate helps you build a portfolio that is tailored to your needs. Download the app today!

10. Frequently asked questions 

10.1 What is the best form of investment?

Every form of investment comes with its own set of pros and cons. In order to decide what would work best for you, you need to first figure out what your goals, risk appetite, and investment horizon are. Once you have done this, you can find an asset class, such as stocks, bonds, mutual funds, or ETFs, that aligns with your financial profile. 

10.2 What are the four most important and well-known types of investments?

The four most important and well-known types of investments for individual investors are stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Each of these investments have a distinct risk-return profile that can help investors meet different investment objectives. Some other well-known types of investments include real estate and commodities. 

10.3 Which investment has the highest growth?

While the returns on any form of investment are never 100% guaranteed, historically, stocks have performed the best compared to other traditional investment options like bonds and mutual funds. The performance of your investments, however, also depends on market conditions and the state of the economy, among other things. 

10.4 Which investment is best for the long term?

Investing in stocks is a great option for the long term because, historically, they have provided significant capital appreciation. Real estate is also a commonly used long-term investment product. 

10.5 What types of investments are high-risk?

Stocks typically carry a relatively high level of risk, particularly stocks of small-cap companies and stocks at the time of their initial public offerings. Other investments that also have a high risk level include non-investment-grade bonds and speculative investments like options and futures.

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