5 Types of Investment Vehicles for Your Portfolio
An investment vehicle is a financial asset (something you own) or account that helps you invest. And lucky for you, there are different types of investment vehicles which means you can build a strong, diversified portfolio.
Here are five types of investment vehicles to get you started with investing (along with the pros and cons of each vehicle).
- Investing in individual stocks means you own a share of a company’s stock and have partial ownership of that company.
- Bonds are investments where you lend money to a borrower to earn interest over time and eventually receive your initial investment back.
- An index fund is a type of investment (normally a mutual fund or ETF) that mimics the performance of a market index to hopefully get the same returns.
- ETFs are baskets of investments like stocks and bonds that are traded throughout the day on a stock exchange.
- Mutual funds are almost exactly like ETFs, but a mutual fund’s shares are only traded once per day instead of throughout the day.
1. Individual stocks
Individual stock investing is where you buy shares or individual stocks in a company. You then become a partial owner of the company. Stocks prove that you have this ownership.
As an example, say that you buy one stock with a company that has 1,000 shares. You’re the proud owner of one-thousandth of the company!
You buy and sell stocks through a stock exchange. If the company issuing the stock is successful, more and more people buy the stocks.
Thanks to the increased demand, the stock prices go up, raising the value of the stock you already own. You earn money through price gains, dividends, and interest. Types of stocks include:
- Common vs. preferred
- Growth vs. value
- Sector or industry
- Large cap vs. small cap
- Domestic vs. international
While investing in the stock market can be risky, you also normally get more bang for your buck over time than you would with a savings account. Historically, the stock market has an average return of 7% each year after inflation (aka prices rising over time).
Fun fact: Stocks are displayed with ticker symbols like AMZN for Amazon, WMT for Walmart, and TESLA for Tesla.
Bonds are investment vehicles where you, as the investor, lend money to a borrower to earn interest over time and eventually receive your initial investment back.
These bonds are issued by treasuries, local, state, and foreign governments, and corporations.
Bonds normally have a fixed interest rate which means the rate never changes. You can then expect the same amount of interest every payment period.
The maturity date – or when the bond issuer has to pay back the loan – depends on the bond. For example, some bonds mature in thirty years. They are less risky than stocks, but also generate lower returns. Some other drawbacks include:
- Not all bond issuers can pay back bond debt.
- Types of bonds (e.g. Treasury bonds) might not be able to keep up with inflation.
- Unlike stocks, it’s difficult to buy and sell bonds on your own.
However, there is the option to invest in bond mutual funds. Your money then goes into hundreds or thousands of bonds.
You also don’t have to wait on bond funds to mature – you can pull out the money and re-invest if needed. There’s also less risk that you’ll lose money if one issuer can’t make their bond payment.
3. Index funds
An index fund is a type of investment (normally a mutual fund or ETF) that mimics the performance of a market index. Instead of trying to beat the market like with trading, you’re matching the market and hopefully getting the same returns.
One type of index is the S&P 500 – an index that holds 500 of the largest U.S. companies. Just like a market index, an index fund is made up of a collection of stocks and bonds.
The investing strategy behind an index fund is simple. Select an index that you want to track. Next, find a fund that tracks this index. You then buy shares of this index fund. To get the most money, it’s best to invest in index funds over the long-term (think 30 years).
Index funds are packed with benefits including
- Low-cost. Index funds aren’t expensive. Since they’re not actively managed (aka portfolio managers aren’t searching for individual stocks), the costs are much lower.
- Easy to invest. You don’t have to spend an excessive amount of time researching individual stocks. Stocks that you want to invest in are already in the fund.
- Low risk. Index funds help you achieve diversification. Since you’re not putting all your eggs in one basket or investment, your risk is lower.
Investing great Warren Buffet is also a strong believer in investing in low-cost index funds over individual stocks. “I recommend the S&P 500 index fund and have for a long, long time…” he says. “I just think that the best thing to do is buy 90% in an S&P 500 index fund.”
Types of popular index funds include Vanguard S&P 500 ETF (VOO) and Schwab S&P 500 Index Fund. You can invest in an index fund through a mutual fund company or a brokerage.
An exchange-traded fund is a basket of investments (think stocks, bonds, and even other assets like gold!). Many ETFs mimic movements of an index like the Dow Jones or the S&P 500. Most ETFs are also index funds (aka indexed ETFs).
Money is pooled from different investors to invest in ETFs. These funds are traded on a stock exchange (just like stocks) and shares are bought and sold throughout a trading day. Some ETFs simply involve buying some or all of an index’s stocks and bonds and holding them (or not selling them) over time.
Other ETFs are actively managed. Investors don’t want to just match market returns. They attempt to beat the market index through investments that they believe will outperform the market. But this approach can be risky and more expensive.
Indexed ETFs are an excellent type of investment vehicle for multiple reasons including
- They have lower fees than mutual funds.
- You can invest in multiple things with ETFs.
- ETFs aren’t normally expensive and you can get started by buying one share.
Popular ETFs include Vanguard Growth ETF, Schwab US Large-Cap Value ETF, and SPDR S&P 500 ETF.
5. Mutual funds
A mutual fund is almost identical to an ETF. It is a collection of assets like stocks and bonds wrapped into one single fund. Money is pooled from different investors to invest in bonds and stocks and generate more money (e.g. through dividends and interest).
Mutual funds can be a mixture of index funds and actively managed funds (aka investors picking out the best investments). However, unlike an ETF, a mutual fund’s shares are only traded once per day instead of throughout the day.
Mutual funds come with multiple benefits:
- Professionally managed by money or fund managers.
- Diverse because you can invest in multiple things with just one fund.
- Affordable as most mutual funds cost hundreds or a few thousand dollars.
But don’t just take our word for it. According to author and journalist Ron Chernow, “Mutual funds have historically offered safety and diversification. And they spare you the responsibility of picking individual stocks.”
Now, it’s important to note that mutual funds do come with drawbacks such as high fees and lack of ownership for specific investments. But if you’re looking for a hands-off investment to add to your portfolio, a mutual fund can be a great option!
Build a portfolio with different types of investment vehicles.
These five aren’t the only types of investment vehicles. Cryptocurrencies, Certificates of Deposit (CDs), and even real estate also make the cut. But these five will help you get started creating a diversified portfolio.
Want to learn more? Take the Complete Investing Course (Stocks, ETFs, Index/Mutual Funds) course on Udemy. This course breaks down complex topics like stocks and building a portfolio into easy-to-understand concepts. Check out the course here.