There are many different investments that you can make. The most common types are small- company stocks, large-company stocks, government bonds, and real-estate properties. Each type has its benefits and tradeoffs, and in this lesson, we will cover the most basic information for each investment.
Small-Company and Large-Company Stocks
A stock is a small share of a company; it grows in value when the company grows and falls when the company falls. In addition, stocks yield dividends, which are cash payments per stock, when a company makes a profit. The value of a stock multiplied by the number of stocks of a company is equal to its market capitalization, which equals the total value of a company.
While there is no official cut off between a large company and a small one, a common definition of large-company stocks is the S&P 500 Index, which is composed of the 500 largest companies in the US, and a common definition of small-company stocks is the smallest 20% of companies in the New York Stock Exchange (NYSE).
These are far more lucrative than the other investments, and small-company stocks are the more lucrative out of the two; for example, on average, one dollar invested in small-company stocks in 1926 would bring $21,997.36 by the end of 2012. Over the same period, a dollar of large-company stocks grew to $3,247.50. Why then would anyone invest in anything but stocks? Well, stocks are riskier than most other investments; small companies, and even large ones, fail often. In 2008, stocks fell by about 40%, and in 1932, they halved in value. In comparison, the total annual returns of bonds fell by only 10% in 1932.
Bonds are essentially a loan from the buyer of the bond to the seller, which is usually the government. Hence, they are a type of debt security. When you buy a bond you pay a sum of money and in return, you get a piece of paper. That paper entitles you to an annual payment of interest on the initial sum, and at the maturation date, you can return the paper for the initial sum; the maturation date and interest rate are decided at the time of sale and cannot be changed.
Bonds are more modest in growth; a dollar of US bonds in 1926 would net $112.14 in 2012, which is far below the growth of stocks; however, bonds are, on average, far more stable. On principle, the US never defaults on its bonds, and since the interest rate is fixed, you know the returns of a bond. That being said, not all bonds are safe; countries like Argentina and even England have defaulted or renegotiated bonds. However, there are many financial services which rate the security of bonds, and allow you to choose the safest.
Short-Term Treasury Securities
Technically, all treasury securities are bonds, but short term treasury securities are called treasury bills or T-bills. T-bills have a maturation date ranging from a couple of days to a year from the date of the sale, but instead of paying interest, they are bought at a discount rate of the face value and are payed back at face value at the maturation date.
Real Estate and Commodities
Real estate and commodities are more traditional investments. Real Estate includes but is not limited to buying a house in hopes that the value will grow or in hopes of renovating it to increase the value. Commodities are any physical object of value; this includes gold, diamonds, art, and even iPhones.
On average, these are much poorer investments. Gold only grew from $295.78 per ounce to $1,813,31 per ounce from 1926 to 2012. In other terms, $1 invested in gold would grow to $6.13, failing to beat inflation. The median cost of a house grew from $6,000 to $219,600, or a 3,660% growth.
Investing is important as well as choosing the right investment which undoubtedly depends entirely on your situations; sometimes high risk and high return makes sense, like for financial experts or people looking to grow their wealth. And sometimes low risk and low reward makes sense, like for people saving for retirement. Additionally, pouring all your money into one type of investment should not be done. Similar to holdings in the stock market, you need to diversify what you invest in.