Different types of investments and how they work
As an investor, you have numerous options for where to invest your money. In fact, there are so many different types of investments, that it can get intimidating; but it doesn’t have to be.
In this article, you’ll learn everything you need to know to successfully navigate among all the investment options.
The best way to understand different types of investments is through the asset-class lens. An asset class is a group of investments that have similar financial characteristics, behave in a similar way, and are bound to the same laws and regulations.
We know of several main asset classes from which different types of investments are derived.
An overview of different types of investments
In general, there are 7 main asset classes, more than 30 different types of investments, and thousands of financial products for each type.
The financial industry is constantly innovating and marketing new financial products, some of them being great investment opportunities, and others not so.
In the table below you can find a general overview of the different asset classes and investment types:
|1. Cash & Currencies||2. Equity||3. Fixed income – Loan||4. Real Estate|
The money market Funds
VC / PE Funds
Debt mutual funds
|Residential properties Commercial properties |
Real Estate funds
|5. Commodities||6. Crypto||7. Collectibles||8. Other|
|Precious metals |
|Crypto currencies Crypto projects||Art |
Other collectibles (cars, furniture…)
|Hedge funds |
Derivates – Options and futures
Insurance & annuities
Now let’s systematically dissect the main asset classes and the most popular types of investments:
1. Cash and cash equivalents
Cash is all about liquidity and purchasing power. You need cash to cover your costs, buy goods, and get through emergency situations. You also need cash available when good investment opportunities arise.
Cash is king in this regard. When it comes to cash it’s recommended to:
- Build an emergency fund for 3 – 12 months of your costs.
- Keep enough cash for your daily life and good investment opportunities.
- Avoid becoming illiquid, meaning you runs short on cash, and you’re force to sell investments at the wrong time.
1.1. Savings accounts
As you know, people usually have cash for liquidity purposes in their current or savings account. It is important not to mix a savings and deposit account.
For the savings account (short-term deposit), interest is paid on the amount of money in the account, and you still have access to the savings when needed. Savings accounts usually come with a variable interest rate that fluctuates over time.
The interests on savings accounts is negligible nowadays, or even worse – in some countries if you have too much money in your bank account you have to pay small penalties, meaning you have negative interests.
Having money in savings account is not considered an investment, but rather a form of saving and preserving money. Nevertheless, an important part of your investment strategy must be planning and satisfying your liquidity needs.
1.2. Deposits / CDs
Deposits (or CDs – certificates of deposit) are a special form of (long-term) savings account offered by banks.
A savings account has a variable interest rate; but deposits, on the other hand, most often come with a fixed interest rate, when you lock away an amount of money for a certain agreed length of time.
This also means you have no access to the deposited money until the agreed term ends, but you receive guaranteed interest. As savings accounts, CDs also have minimal interest rates, and are today hardly considered as a profitable investment.
1.3. Foreign currencies
Just as you can hold savings in a domestic currency, you can also hold short or long-term deposits in other currencies.
Investors often hold different currencies in their portfolio, most often Swiss Francs, Japanese Yen, Euros, or US dollars, especially if they believe the foreign currency will appreciate in comparison with the domestic currency, or for the purpose of acquiring better interest rates.
Active trading on foreign exchange markets (Forex) is also quite popular, but we can’t easily put such a set of trading strategies in the asset class of cash and cash equivalents due to different risk exposures and leverage.
Equity means owning part of the business or, in other words, being a shareholder in a company.
You can have a share in a public company (listed on a stock exchange) or a private company (e.g., through crowdfunding or an angel investment). You can be a direct owner of a company or indirectly own one (through a fund, SPV, or similar). Direct or indirect ownership goes for most asset classes.
In the equity asset class, we can find the following types of investments:
|Type of an investment||Ownership of equity||Public / Private|
|Stocks listed on exchanges||Direct||Public|
|VC / PE Funds||Indirect||Private|
|Equity crowdfunding||Direct / Indirect||Private|
Let’s look at the most popular equity investment types a little more closely:
A stock (or a share) is a tradable ownership in a part of a company. When you buy a stock, you own part of the publicly traded company, and as the company grows, its value and your investment also have a great chance to do so. As well as this, you are entitled to a dividend based on the profits generated by the company.
Publicly traded companies are often less risky compared to private companies. It is possible to own shares in the world’s most renowned companies, such as Apple, Coca Cola, Tesla, and others.
It’s also quite easy to buy a stock, and this is why stocks are one of the best ways to create wealth.
It is, however, important to keep in mind that stocks are still considered a risky investment as they can lose a significant part of their value on the market (as we will see in the last chapter where we add risk, liquidity, return, and sophistication to different types of investment)
2.3. Equity mutual funds
If you don’t want to pick specific stocks and build a portfolio on your own, you can invest in a mutual fund, index fund, or ETF.
A mutual fund is a professionally managed fund that pools money from many investors and then invests that money in different securities (mainly stocks, bonds, or a mixture of the two), depending on their investment strategy.
An equity mutual fund’s investment strategy is focused on stocks, meaning most of the portfolio holdings are in stocks. A mixed mutual fund owns stocks and bonds, and a bond mutual fund mainly holds bonds, as we will see later.
Here are the differences between mutual funds, index funds, and ETFs:
|Type of an investment||How it’s usually managed||How it’s bought|
|Mutual fund||Actively managed – management chooses investments||Priced once at the end of each trading day and bought from the fund provider.|
|Index fund||Passively managed – follows an index, region, sector, commodity …||Priced once at the end of each trading day and bought from the fund provider.|
|ETF||Passively managed – follows an index, region, sector, commodity …||On the stock exchange, in the same way as a stock.|
2.4. ETFs and index funds
ETFs (Exchange Traded Funds) contain a collection of different investments such as bonds, stocks, etc., and usually track a specific index, region, sector, or commodity. Like stocks, they are listed on the market in the same way as shares, and have lower fees compared to mutual funds.
Index funds are similar to mutual funds (in that they aren’t listed, but bought from the fund provider), whereas their strategy is to follow a specific index.
An important distinction is also that mutual funds and index funds are priced once at the end of each trading day, while ETFs can be bought or sold on exchanges during trading hours with the price being set on the fly.
The investment strategy based on ETFs and index funds is often called indexing. Since there are many mutual funds and ETFs to choose from, the most often recommended strategy is “core and satellites”, which means you choose one general, very well diversified ETF/index fund, and then a few with a narrower focus (energy, tech, emerging markets, etc.).
2.5. Owning a private company
Beside owning a publicly traded company, you can also own a private company, i.e., a company not listed on a stock exchange, which means there’s less regulation, limited access to information, and it can get little bit more complicated to buy a share in the company.
Investment opportunities in private companies are also most often in the earlier stages (start-ups, scale-ups, etc.), which means investments are much riskier, but potentially also much more profitable.
You can become an owner of a private company in several ways:
- Starting your own business
- Investing in a company your friends or family members start
- Investing as a business angel
- Investing in a venture capital / private equity fund
- Equity crowdfunding
- Participating in secondary markets for private companies
3. Fixed income / Loan
Lending money usually comes with a fixed interest income. In this type of investment money is lent to a government, business, or individual with the hope getting back the principal along with the agreed interest rate in the agreed time frame. The interest rate depends on how the big risk is.
Deposits and bonds are considered lower risk investments, since the borrowers are usually countries, banks or corporations. On the other hand, debt crowdfunding and P2P lending can be much riskier investments, which also means higher interest rates.
The main options when it comes to lending are:
When buying a bond, the purchaser is lending money to the issuer. Instead of going to the bank, the issuer borrows money from the investors who are willing to buy their bonds.
Most often the issuers of bonds are governments, municipalities, and corporations. Each bond has a maturity date, which is a set period of time over which the principal is paid back to the investors.
A bond can have fixed or floating interest rates. Interest amounts paid out are called “coupons”. Most often, interest rates are paid annually or bi-annually. A bond can be sold before it matures on “the secondary market”. The price of a bond on the market depends on the bond yield, the movement of interest rates, issuer rating, and supply and demand.
Bonds are considered less risky investments than stocks; nevertheless, there is still a risk of default present, meaning the issuer is not able to repay the loan in time. If the issuer goes bankrupt, the bondholders still have the right to claim the issuer’s assets, i.e., any assets used to secure the bond (real estate, etc) .
When buying a bond, you don’t own any equity. No matter how high a corporation’s profit is or how much the stock price soars, the maximum investors can get back is the principal, along with the agreed interests.
On the other hand, a corporation is legally obliged to pay back the loan, whereas paying out dividends is up to a management or shareholders decision, based on the company’s profits.
3.3. Debt mutual funds
Just as we know about equity-oriented mutual funds, we also know about debt-oriented mutual funds (and ETFs). The debt mutual funds hold a diverse selection of fixed income securities.
Diversification and convenience are usually the main factors that push people to buy debt mutual funds rather than bonds directly; however, this also means higher costs.
It’s also worth noting that the most frequent purpose of bonds and bond mutual funds, besides generating a relatively stable income, is to provide some stability to a portfolio, especially in a market downturn.
3.4. Accounts receivable financing
A very specific type of investment, but worth mentioning are accounts receivable. The main idea behind financing account receivables is that businesses can more quickly turn their invoices into working capital.
Many businesses have to wait for weeks or even months for their customers to pay the invoices.
Financing accounts receivable enables businesses to get advanced payment on the invoices that have a longer due date. They can consequently reinvest the money more quickly into their growing business. An investor who is financing the account receivables gets repaid with the agreed interests.
3.5. P2P Lending and loan crowdfunding
Peer-to-peer lending (P2P lending) and loan crowdfunding enables investors to lend money to individuals or businesses through an online platform that matches lenders with borrowers.
There is usually no financial institution in-between that would underwrite or guarantee these loans. Most often, a higher number of investors participate in a particular loan. The loan can be secured or without any collateral.
Because of the greater risk in such lending, in general, interest rates are much higher compared to bonds and bond mutual funds. It’s also worth mentioning that legislation in some countries doesn’t allow P2P lending.
4. Real Estate
With a real estate investment, you own a part of a physical space that can be put to good use. The use of space can be for commercial, residential, farming, or similar purposes.
The main options when it comes to real estate are:
4.2. Residential and commercial properties
The first option you have when it comes to real estate investment is to directly buy real estate and then rent it out (long-term or short-term through Airbnb for example).
Individual investors most often buy residential properties (a flat, a house …) and then collect rent. Besides having a regular cash flow from the rent (passive income), real estate appreciation is a desired outcome.
As with all investments, real estate prices fluctuate with macroeconomic cycles. The profitability of a real estate investment thus greatly depends on where, when and for how much you buy the real estate.
The main idea is, as with all the investments, is to buy when the prices are low, and sell when the prices are high.
The second important aspect when it comes to real estate is the leverage, meaning you can increase your returns with the use of debt financing (a mortgage). Using leverage also means the real investment is more accessible, since you only need a portion of the property’s value in cash for a down payment.
But on the other hand, interest rates on the market present an important aspect of how attractive an investment is.
4.3. Real Estate Investment Trusts (REITs)
REITs are trusts which buy properties with the intent to collect rent as the main source of revenue. In other words, they invest in income-generating real estate projects. An important specific about REITs is that they have to pay out a big percentage of their taxable income to shareholders (in the US, more than 90 % for example).
A REIT can be publicly traded or not. If it’s publicly traded, it’s possible to buy shares of a REIT in the same way as a stock. Non-public REITs can be bought through a broker or invested directly via the manager of the REIT.
4.4. Real estate ETFs and funds
As we learned with equity and debt mutual funds, a fund pools money from many investors and then invests the money, in this case in real estate.
There are several main types of real estate funds:
- Real estate ETFs (passively managed)
- Real estate mutual funds (actively managed)
- Private real estate funds (accessible only to accredited investors)
- NPL (non-performing loans)
Real estate ETFs and mutual funds most often buy securities offered by public real estate companies, including REITs. They don’t invest directly in real estate projects. Private real estate funds, on the other hand, invest directly in real estate projects and are only accessible to accredited investors.
A special sub-category of real estate funds and investment strategy is investing in non-performing loans (NPLs) backed by real-estate. In practice that means a fund takes over a non-performing loan and the underlying real estate as a collateral, and often takes over the management of the real estate or sells it off.
4.5. Real estate crowdfunding
Real estate crowdfunding means that you invest directly in a particular real estate project based on your own choosing through a platform that connects real estate projects with the general public.
This means you must carefully perform due diligence and make sure that experienced developers are behind the chosen project. Nevertheless, real estate crowdfunding is one of the best ways for smaller investors to invest in this asset class.
|Real estate fund||Real estate crowdfunding|
|Who can invest?||Experienced investors||Anyone|
|What is the investment size?||Big (over 100.000 EUR)||Small|
|Who chooses the project?||Management||You|
|How can you invest?||Through a fund provider||Through a crowdfunding platform such as Equito|
Commodities are raw materials and primary agricultural products (oil, copper, wheat…) or precious metals (gold, silver) that can be bought and sold on the market. Investing in commodities means purchasing these kinds of goods with the hopes they appreciate in value.
Let’s look closely at the most popular commodities:
5.1. Gold, silver, and other precious metals
Gold is the most popular precious metal when it comes to investing. We can also add silver to the list, although it’s not as nearly as popular as gold. Gold doesn’t corrode, it looks beautiful, it’s easy to work with, it’s scarce, and it’s difficult to extract.
Many invest in gold to balance their portfolio and as financial protection in turbulent times (e.g., wartime), since it’s considered a safe-haven asset. Some investors also combine investing in gold with their collecting interest, meaning buying gold coins, jewelry and similar.
The other popular precious metals on the market besides gold and silver are:
5.2. Raw materials
Commodities are raw materials such as corn, oil, copper, etc. Commodities are traded on the market where prices are determined, which is why it’s called “commodity trading”. Commodity trading rarely involves physical trading, but is rather done through futures contracts.
A futures contract is an agreement where an investor buys or sells a commodity for an agreed price at a specific date. That offers an opportunity to earn (or lose money).
Commodities are considered a very specific asset-class that you must really master in order to mitigate the risks. Commodities are highly volatile, which means highly risky, but they can provide some diversification to the portfolio.
The most commonly traded raw commodities are:
- Oil and natural gas
- Wheat, corn and soybeans
Crypto is the youngest asset class, and thus it comes with many unknowns. In other words, it offers many new ways to earn (or lose) money.
Since crypto is driven by innovation and disruption, you can find investment opportunities that mimic almost all other asset classes – from investing in “digital gold” (Bitcoin), to buying tokens (alternatives to shares) in crypto projects, to staking your crypto asset at a fixed rate to provide a fixed income.
The main options for making money when it comes to the crypto asset class are:
- Investing / Trading
- IDOs / DAOs (buying tokens)
These points will be explored more in another article.
7. Alternative investments, collectibles, and NFTs
Collectibles are valuable items that have a much greater price in comparison to the time when they were originally created. These types of investments are most often considered alternative investments, and can be rare items, such as:
- Old furniture
- Old timers (cars)
Let’s also not forget about NFTs (non-fungible tokens), which are the most contemporary type of digital collectibles. NFTs are a way for investors to buy collectible items (usually digital images, videos, etc.), with the use of blockchain technology that provides proof of digital ownership.
8. Other types of investments
8.1. Hedge funds
Hedge funds are special kinds of funds accessible only to accredited and institutional investors. As mutual funds, hedge fund managers pool money from investors, in this case a small number of large investors, and usually follow a very aggressive investment strategy, which is not heavily regulated.
Hedge funds can put money into any type of investment, but generally invest in derivates and investments with a leverage. Hedge funds can have different investment strategies, among which the most popular are: arbitrage, global macro, directional, and event-driven.
8.2. Derivates – Options and futures
Derivates are not an asset class per se, but rather financial derivates, which means they are linked to a specific asset class but traded in their own right. With an option, you buy a contract that gives you the option to buy or sell an underlying asset at a certain price within a specific period.
As the name implies, with an option, you have the option of buying or selling, but you are not obliged to do so.
We know two different kinds of options: A call and a put option. Owning a call option gives you the right to buy the underlying asset, and owning a put option gives you the right to sell it. All options are sold for a price called a premium. Options are considered a very risky investment, appropriate only for very experienced investors.
We’ve already mentioned futures with trading raw commodities. Futures are contracts that obligate buying and selling parties to trade a certain asset at a predetermined price on a predetermined date. If an option gives you a right to execute a transaction, a future contract means an obligation in this regard.
Besides being bought and sold on commodity markets, you can also find future contracts on currencies, interest rates and indexes.
8.3. Insurance and annuities
Last but least let’s mention insurance. Insurance is an important part of any personal investment plan, although it should not be considered as an investment, but rather as a form of wealth protection.
With insurance, you can protect yourself in case of an illness, job loss, or similar circumstance. You can also financially protect your family in the unfortunate case of your death.
Insurance companies often offer special products, like annuities, where you pay insurance premiums and are then guaranteed a fixed income in retirement, although such products often come with high fees and poor inflation protection. Insurance companies should be mainly used for insurance, and not as an investment vehicle.
9. Risk, liquidity, potential return, and sophistication
To take our understanding of different types of investments a step further, let’s add the most important characteristics to each investment type:
Risk – How risky an investment is (for a higher return, a higher risk is always present)
- Low: There’s no risk, or you can lose a small percentage of the investment
- Mid: You can lose a large proportion of your investment
- High: You can lose your whole investment, but you can also earn outstanding returns
Potential returns – What are the average return rates based on past performance?
- Low: 1 % – 3 % p.a.
- Mid: 4 % – 9 %
- High: 10 % or more p.a.
Liquidity – How fast can you convert the investment to cash?
- Low: In a few months or years
- Mid: In a few days or weeks
- High: Immediately
Sophistication – How much knowledge and understanding do you need?
- Low: It’s an investment type that is easy to understand
- Mid: You need to invest a certain amount of time to understand the investment
- High: You must be an accredited investor with sophisticated knowledge
Now you should have a good overview of the different asset classes and investment types available. The next step is to choose a few of them that fit your investment strategy best and then build your information flow to identify good investment opportunities.
You must perform thorough research to really understand how the chosen investments work and build your optimal portfolio. Investing is, in the end, one of the best ways to generate wealth, if you approach it in a knowledgeable and systematic way.