9 Types of Investments for Beginners

With so many types of investments to choose from, which ones are right for your portfolio? In this post, I’ll provide an overview of 9 different types of investments for beginners and their historical performance so you can decide what’s right for your portfolio.

Stocks

The ownership of publicly traded (and some private) companies are divided into shares of stock. 

For example, if there are only 100 shares of stock of a company, and you own 1 share, then you own 1% of the company. 

As of this writing, there are 4.334 billion outstanding shares of Apple.

You would have to own 43 million shares of Apple to own 1% of the company.

Currently at $388 a share, this would set you back a measly $16.7 Billion.

Historic Return: Between 2005 and 2019, small stocks have a compound annual return of 7.92%, while large stocks have a compound annual return of 9%. (Source: Novel Investor)

Bonds

A bond is just a loan that pays interest in the form of coupons.

A bond issuer sells its bond to the bond holder. The bond holder receives interest at the coupon rate (typically every 6 months) and receives all of her money back at the bond maturity date.

Corporations sell corporate bonds to raise cash for their operations.

Municipalities like states and counties also sell bonds to raise cash for expenses or large infrastructure projects, and pay back the bond via taxes it collects.

Why sell bonds when they can borrow from a bank?

In some cases, it is cheaper to sell bonds that to borrow from a bank, so Corporations and Municipalities will often sell bonds on at more favorable interest rates.

Here’s an example of how a bond works:

• A bond has a coupon rate of: 7.5%
• Maturity date of: 5/30/22
• Bond purchase date: 6/1/16
• Bond purchase price: $106

You buy 10 bonds at $106 each for $1060. 

Every six months, you receive $37.5 in interest (aka coupon) because the face value of the bond is $100, and (7.5% divided twice a year)*100 = $37.5

At the maturity date of the bond, you will receive the last coupon and the face value of the bond back.

Here’s what it looks like in excel:

When you add up all of the cash flows, the effective yield-to-maturity (YTM)(aka yearly compound interest rate) in this example is 6.38%.

Each bond is assigned a risk rating based on its predicted ability to pay its debt obligations. 

Investment-grade bonds are considered relatively lower-risk (and lower-return) than non-investment-grade bonds (also known as junk bonds) which provide a higher-return.

Here is how the most popular rating agencies categorize bonds:

Source: https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/junk-bonds/

Historic Return: According to the same NovelInvestor study, between 2005 and 2019, high grade bonds had a compound annual return of 4.15% and High Yield Bonds had a compound annual return of 7.35%.

REITs (Real Estate Investment Trust)

An REIT is a company that owns an investment portfolio in real estate. The portfolio may contain office buildings, apartment complexes, data centers, healthcare facilities, hotels, retail centers, and warehouses.

According to Investopedia, an REIT leases space and collects rent on the properties then distributes the income as dividends to shareholders. 

You can invest in publicly traded REITs, REIT mutual funds, and exchange-traded funds (ETFs). 

REITs can provide you the ability to invest in real-estate, but rather than owning a physical property that you need to rent out and maintain, you just own shares of the portfolio. This can give you increased liquidity over buying a property outright. 

Historic Return: According to the same NovelInvestor study, between 2005 and 2019, REITs had a compound annual return of 8.35%.

Options

An option is the right to buy or sell at asset at a future date and at a fixed price.

A call option is the right to buy an asset, at a fixed price, before or on an expiration date. 

Example (Call Option):

Let’s look at an example call option for Microsoft: 

Call option price: $21.39

Strike price: $200

Expiration date: November 20 

To purchase this call option, you would pay $2139 (an option is purchased in increments of 100). In return, you’d have the option to purchase 100 shares of Microsoft for $200 each at any time between now and the expiration date of November 20. The stock would have to reach $221.39 (the option price + the strike price) before the expiration date for you to break even.

You would purchase this option if are bullish on Microsoft stock and you predict the stock will rise to above $221.39 per share by the expiration date

A put option is the right to sell an asset, at fixed price, before or on an expiration date. 

Example (Put Option):

Here’s an example of a put option for Microsoft:

Put option price: $14.03

Strike price: $200

Expiration date: November 20 

To purchase this put option, you would pay $1403 (an option is purchased in increments of 100). In return, you’d have the option to sell 100 shares of Microsoft for $200 each at any time between now and the expiration date of November 20. The stock would have to reach $185.97 (the option price – the strike price) before the expiration date for you to break even.

Not only can you purchase call options and put options, but you can sell them too.

Treasury Bills

According to Investopedia, a Treasury Bill (T-Bill) is a short-term debt obligation backed by the U.S. Treasury Department with a maturity of one year or less. Treasury bills are usually sold in denominations of $1,000 while some can reach a maximum denomination of $5 million. The longer the maturity date, the higher the interest rate the T-Bill will pay the investor. 

Treasury bills can be purchased though a bank, a broker, or through the federal website TreasuryDirect.gov

Historic Return: According to the same NovelInvestor study, between 2005 and 2019, 3-month treasury bills had a compound annual return of 1.3%.

Types of Investment Funds:

Index Funds

An index fund is a portfolio that closely tracks and mimics the performance of an index such as the S&P 500, Dow Jones, Nasdaq, etc. 

Index funds typically have low fees because it requires minimal, if any, management by a professional portfolio manager. 

Index funds are my favorite type of investment because of its low maintenance, low fees, and strong long-term performance. 

Example:

Schwab’s S&P 500 Index Fund SWPPX seeks to track the total return of the S&P 500 Index and has a net expense ratio of just 0.02%.

Historic Return: According to the same NovelInvestor study, between 2005 and 2019, an index tracking the S&P 500 had a compound annual return of approximately 9%.

Mutual Funds

A mutual fund can consist of a portfolio of different investments like stocks, bonds, or other securities. A mutual fund typically charges fees higher than what you’d come across with index funds because it is managed by a professional portfolio manager.

Mutual funds can only be bought and sold once per day and are priced once per day after the market closes.

Example:

Schwab Core Equity Fund SWANX seeks to assemble a portfolio with long-term performance that will exceed that of the S&P 500 Index. However, it has a significantly higher net expense ratio than the index fund, at 0.73%.

Even though SWANX attempts to outperform the S&P 500, it is clearly not succeeding, driven in part by its high fees.

Exchange-traded funds (ETFs)

ETFs are similar to mutual funds, except that they can be traded multiple times per day, and their prices can fluctuate throughout the day like stocks. ETFs often have lower associated fees than mutual funds because they are typically passively managed.

Example:

Invesco QQQ Trust seeks investment results that generally correspond to the price and yield performance of the NASDAQ 100 Index. It has an expense ratio of 0.2%.

Bonus:

Gold

Commodities like Silver and Gold tend to get a lot of attention, sometimes before and during recessions, and sometimes rather randomly. 

Some investors feel that gold is a safe hedge against inflation, since cash can be printed ad nauseum, while the supply of gold remains relatively constant. 

Historic Return: Between 2005 and 2019, gold had a compound annual return of 8.85% and according to DQYDJ’s online calculator.

Putting it all together:

Different types of investments have different risk/reward ratios and therefore different average investment returns. Therefore, it is important to understand what they are and how they work.

Investment Returns:

Here’s a chart of the 15 year annualized compound returns from 2005 to 2019 of some of the types of investments mentioned in this post.

Source: https://novelinvestor.com/asset-class-returns/

Past performance does not guarantee future results, but it should provide a pretty good estimate over a long time frame.

Every so often, it may be a good idea to examine your risk tolerance and financial goals to decide what types of investments you decide to include in your portfolio.

Let me know your thoughts below!

Which types of investments are in your portfolio?