Types of Investment Vehicles to Make Your Future Less Murky
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We all have different financial goals at different points in life. College, a home, baby, car, emergencies, retirement, or just a vacation are some big things to save for.
Saving for any of these through anything other than a basic savings account, which is a good start, can put you ahead of the game and make saving easier. Many investment vehicles can pay off through profits, dividends, and interest, among other ways, and can earn you enough to possibly reach your financial goals early.
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Why different investment vehicles are important
Making your money work for you, even when you’re asleep, can often be done through investments. An investment strategy can include different kinds of investment vehicles, based on the period of time before you’ll need the money, risk tolerance, and liquidity needs.
An investment’s volatility is also a factor since high volatility often means high risk. If your risk tolerance isn’t high enough, then you may not want to make that investment.
Real estate, for example, is usually a long-term investment that can take five years or longer to profit from, so investing your emergency fund in real estate investment trusts, or REITs, may not be the best choice if you need to pull out money immediately for an emergency such as a hospital visit or you lose your job.
Diversification is also important when choosing investment vehicles. Having a variety of long- and short-term investments where some are low-risk and others have higher levels of risk can give you varied rates of return. A diversified portfolio is a smart way to spread out your financial risk.
In this story, we’ll review some of the main types of investment vehicles, their costs, and the pros and cons of each. By the end, you should be able to match an investment vehicle to the financial goals you aim to meet. And if you need help, a financial advisor may be worth hiring.
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Types of investment vehicles
Certificates of deposit
Certificates of deposit can be a good way to stash your money away for a few months or longer while earning interest.
The interest rate currently isn’t great on CDs, though they’ve been going up since March 2022. CDs usually pay higher interest rates than savings accounts. An average one-month CD pays 0.03% interest, and goes up to 0.32% for a 60-month CD as of April 18, 2022, according to the FDIC.
CDs are insured by the FDIC for up to $250,000 and are considered safe places to park your money. A CD has a maturity date of one month to five years, and withdrawing your money before it matures usually means paying a penalty.
Splitting some of your money among CDs can be a good way to earn some interest on an emergency fund, provided they have different maturity dates so you can have some liquidity.
Related: CDs (Certificates of Deposit) – Savings at Higher Returns Than Traditional Savings Accounts
Exchange-traded funds (ETFs)
Exchange-traded funds, or ETFs, are a way to invest in a range of stocks, bonds or other assets. ETFs are traded on an exchange just like stocks are. They usually have low expense ratios and broker commissions and are an inexpensive way to come up with a diversified portfolio.
ETFs can be tied to investment strategies or benchmarks such as the S&P 500 Index. They’re typically long-term, stable investments that follow a buy-and-hold investment strategy.
Some ETFs also have tax advantages. A capital gains tax is paid in years when you sell an ETF and not throughout the life of the investment. ETFs that pay dividends, however, requires paying income tax in the year the payout was received.
The S&P 500 is a benchmark for returns and has an annualized return of 10.5% since its inception. The average exchange-traded fund also has an average return of around 10%.
Related: Best ETFs of 2022
Index funds
Index funds are a type of mutual fund or exchange-traded fund with a portfolio selected to match or track parts of a financial market by following a benchmark index such as the S&P 500 or the Nasdaq 100.
The S&P 500 Index, which we mentioned above, tracks about 500 of the largest companies in America such as Amazon, Apple, Microsoft, and Alphabet. An index fund can be set up to invest in the same companies that are in the S&P 500 as a way to mirror their overall performance.
The money you invest in an index fund is invested in all of the companies in that index, giving you instant diversification over buying individual stocks.
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Mutual funds
Mutual funds are another managed pool of individual securities such as stock or bonds that provide diversification. Mutual funds and ETFs are pooled investments with money from other investors. They’re one type of managed funds.
Mutual funds can be bought without trading commissions. But they can have management fees, especially if an active management style is used where fund managers choose stocks based on their research and not in relation to an index or benchmark.
Unlike ETFs, which can be traded throughout the trading day, mutual funds only trade at the end of the day when the market closes.
Mutual funds are common investments in . They can also be bought as an individual investment for any long-term goal, such as paying for college or saving for a down payment on a home.
Mutual funds average or exceed 12% long-term growth.
Related: What Are Mutual Funds?
Retirement account
A is one of the most common investment vehicles. It can be overseen by a fund manager or you can do the money management yourself and pick investments such as index funds, mutual funds, and other long-term investments.
The sooner you start a retirement account the better because it gives you more time for your money to grow and compound.
A traditional 401(k) is a common type of retirement account. Employees contribute part of their salary to the account, and the contribution is sometimes matched by their employer up to a certain percentage.
Individual Retirement Accounts, or IRAs, are other types of retirement accounts. A traditional IRA is funded by anyone earning an income, and they can deduct contributions from their taxable income. In a Roth IRA, taxes are paid upfront instead of when distributions are made in retirement.
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Money market funds
Money market funds are mutual funds that invest in cash and cash equivalent securities such as certificates of deposit and U.S. Treasuries.
Rules from the Securities and Exchange Commission require them to have a weighted average maturity of 60 days or less, giving them high liquidity.
Money market funds have a similar name as money market accounts or MMAs, but they’re different. Money market funds are sponsored by fund companies and don’t guarantee the principal, while money market accounts are interest-earning savings accounts insured by the FDIC.
Money market funds usually pay a higher interest rate than MMAs. They’re also considered safe investments by buying debt securities issued by banks, large corporations, and the government that carries low default risk.
On average, these funds generate income that’s slightly above the rate of inflation. They’re a good place to put your money for a few months, such as for an emergency fund, and aren’t meant for long-term investments such as a retirement account.
Real estate
Being a real estate investor can come in many forms. You can buy a home and fix it up and sell it for a profit. You can buy an apartment complex and rent units out to renters for a type of passive income. You can just rent out a room in your home.
Those can require a lot of work and may require you to be a landlord, though you can hire people to do much of the work for you.
A much easier option is to invest in real estate investment trusts or REITs. They’re just one way to invest in real estate but are a common one.
REITs are companies that own income-producing real estates such as apartment buildings, commercial property, hospitals, hotels, and individual homes. Money can be paid to investors through quarterly dividend payments that come from rents, or a share of profits when the value increases and the property is sold.
Real estate isn’t just for the very wealthy. Investors of nearly every income level can invest in this method, with some REITs requiring only $5 to start as an investor. REITs can provide a predictable cash flow with appreciating assets that are often a hedge against inflation.
REITs gained nearly 29% in 2021, though the average yield is 2.9%. Real estate can be a volatile investment, taking five years or longer to realize a profit. Still, it’s an asset that usually gains value and often rises when stocks fall.
Cryptocurrencies
Cryptocurrencies carry a high risk, but a chance at a high rate of return too, from 59% to 12,967%, according to 2021 data. The value can also drop to zero.
Cryptocurrencies aren’t backed by a government, as the U.S. dollar is. Instead, the price of digital currency such as Bitcoin and Ethereum depends only on what traders will pay.
They can be bought at brokerages and at trading apps such as Robinhood. Cryptocurrency can also be bought through exchanges such as Coinbase or Binance.
Closed-end funds
Closed-end funds allow investors to add alternative investments to their portfolios such as futures and foreign currency. They also include municipal bond funds, which invest in local and state government debt and try to minimize risk.
Closed-end funds can also be mutual funds that issue a fixed number of shares through a single initial public offering.
Share prices of closed-end funds are often volatile, and traders often price them at a discount or premium.
Hedge funds
Hedge funds are private, pooled investment funds that seek high returns through risky investment strategies and can put the participants’ money in anything from publicly-traded securities to startups. Hedge funds are a type of private equity, where money is invested in private companies.
They’re private investment partnerships managed by a partner who makes all of the decisions. Hedge funds are considered one of the more sophisticated types of investments and can come with a lack of transparency while facing fewer regulations.
Investing in a hedge fund can require having a net worth of at least $1 million, or earning at least $200,000 annually. They may also have a high minimum investment amount.
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Costs
Each type of investment can have its own costs.
Mutual funds and exchange-traded funds, or ETFs, can usually be bought without trading commissions.
One of the biggest costs of owning a mutual fund is its management fee. It’s expressed as a percentage, or expense ratio, of your overall investment. Managed funds typically have an expense ratio from 0.5% to 1.5%, and passively managed funds have 0.2% expense ratio. Anything higher than 1% is considered very high.
In 2020, the average stock index mutual fund charged 0.06%, or $6 for every $10,000 invested. The average stock index ETF charged 0.18%, or $18 for every $10,000 invested.
Real estate investment trusts, or REITs, can have high upfront fees of 9-10% of the investment. Federal law requires REITs to pay out at least 90% of their taxable income to investors.
Roth retirement accounts don’t require paying taxes on withdrawals during retirement. Other types of accounts, such as a 401(k), require paying taxes on withdrawals in retirement. Retirement accounts may also incur fees. The average fee for a 401(k) participant was 2.22% of their assets, with a range between 0.2% and 5%.
Buying or selling closed-end funds can require paying a commission to your broker. The funds also have high fees, averaging 1.09% annually, or $109 for every $10,000 invested, according to Kiplinger.
When buying cryptocurrencies, your broker may charge a fee. Exchanges such as Coinbase do, charging fees from 0.5% to 4.5%.
Money market funds can be bought from big brokerages such as Fidelity and Vanguard, or directly from a bank. A report by the Investment Company Institute found that the average money market fund charged 0.22%, meaning you’ll pay $22 for every $10,000 invested.
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Pros and cons
Pros
- Using different investment vehicles is a good way to create a diversified portfolio, both in risk and the period of time investment will be held.
- Using this investment strategy can help you fund short-term and long-term financial goals.
- Some of these methods can lead to passive income.
Cons
- Some investments carry a high risk, and it’s worthwhile to be aware that you could lose all of your money in such an investment, and that you can afford it.
- Hedge funds can require a high income, so you may not qualify as an investor.
- Fees and other expenses of investing add up over time, so check that they don’t take away from the principal.
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The bottom line
Different types of investment vehicles are needed for different financial goals throughout life. By picking ones where the risk matches your timeline, such as low-risk certificates of deposit for a few months until you need the cash, you should be able to earn positive returns over your lifetime. Long-term goals such as funding a retirement account can lead to riskier investments if you have decades until retirement.
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Writer
Aaron Crowe is a freelance journalist who specializes in personal finance writing and editing. He has worked at newspapers, where he won a Pulitzer Prize, and has written for numerous online publications. These include AOL, US News & World Report, WiseBread, Bankrate, AARP, and many websites focusing on housing, credit and insurance. He lives in California with his wife and daughter.
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