6 min read

4 types of investments (+ examples)

Picture of Chris McAlpin Chris McAlpin : Mar 19, 2024 12:18:22 PM

We’re going back to financial school today, everyone. I don’t care if you’re new to investing or you consider yourself at least marginally well-versed in investment terms, I wrote this primer for you.

The backbone of any successful investment strategy — yours, in this case, hopefully — is built upon a foundation of knowledge. More specifically, knowledge of the financial tools at your disposal in the sphere of investing.

4 types of investments

The four types of investments (your investing “tools”) are:

Stocks
Bonds
ETFs and mutual funds
Annuities

In this article, you’ll learn what each of these types of investments are, as well as a few of the fundamentals you need to know about each. Will you find advice here about how to structure your own portfolio? No. But before you can even begin to have those conversations, you must have this base-level understanding of what each of these investments are.

Even if you’re working with an investment advisor or some other financial planning professional, the more you are empowered with financial knowledge, the more of an active participant you can be in your own future financial success.

Investment #1: Stocks

We’re going to start with the most commonly recognized type of investment, but I can’t in good conscience overlook it just because everybody’s heard of it — stocks. The most pure and academic definition of a stock is that it’s a type of security that grants the holder of that stock a portion of ownership in a company.

Now, there’s another subtle distinction within stocks that I want to cover here and that’s the difference between traditional value stocks and growth stocks:

Traditional value stocks are where investors will go after older, more established companies that are undervalued and should (in theory) stop being undervalued at some point in the future, and that stock price goes up.
Growth investments, on the other hand, are stocks that are growing into and potentially beyond its fair market value price, so you’re often buying a stock based on the promise of its future success.

The key thing you must always ask yourself when considering a stock for an investment is, “Where does this stock fit in my portfolio?” Does it truly fit in your overall asset allocation? Or are you just buying it because you want to? Now, if you’re answering yes to the second question, that’s OK. However, you should have a defined limit of how much of your portfolio can be used for those types of investments.

Now, for the purposes of today’s discussion, I want to keep my conversation about stocks here educational. However, I would encourage you to read my other articles about investing in the stock market:

Investing in stocks can be very lucrative, but it can also be a highly emotional and risky endeavor — and the media and pop culture don’t really help us in that regard. But my hope is that the above articles can provide you with some hard-won wisdom about how you should approach the stock market.

Investment #2: Bonds

Most will say investing in a bond means you, the bond holder, have loaned the bond issuer (a company or a government entity) money, and now they’re paying you back with interest. For example, if you purchase a $100 bond with a 5% interest rate, the bond issuer will pay you 5% interest on that $100 bond between now and the time that it matures at 5% per year. This is in contrast to stocks, which represent a stake of ownership.

While this is technically accurate, it is an incomplete definition, and here’s why. What you may not realize is that 99% of us purchase bonds on a secondary market (what we consider to be the “open market,”) rather than the primary market, which means you are really buying it as a financial asset at that point.

But what the heck does that mean? Let’s say you go and buy a U.S. Treasury Bond from our trade desk. You’re not actually loaning money to our government. That money has already been loaned, and you’re simply buying the bond from someone who did originally.

Regardless of how you purchase a bond — and keeping in mind that bonds can be complex, with multiple moving parts — you are typically buying a bond for is the constant guarantee interest rate return on the investment.

While bonds may not feel as sexy or as cool as its other investment brethren (particularly, the more volatile stocks), they are very effective as a reliable workhorse in their portion of the asset allocation. More specifically, we can really dial in bonds and get them to do what we want them to do. Now, did Bank of America say 2022 was the worst bond market in U.S. history? Yes, but that does not change our investment philosophy.

While there are a lot of fears surrounding bonds at the moment, we do not believe there should be. We are still in the throes of experiencing financial fallout from the global pandemic. Moreover one year of subpar performance is not necessarily indicative of an emerging pattern — given that the bond market has been around since 1788, this is important to keep in mind.

Clearly, I could write a whole article about the state of the bond market, and I likely will. But that should be enough to whet your palette until that day comes!

Investment #3: ETFs and mutual funds

Now, ETFs (exchange traded funds) and mutual funds are often taught by some as being the same thing, with interchangeable labels — but they are not the same thing.

Let’s talk about ETFs first

ETFs are a basket of stocks, bonds, commodities, and alternatives that are built to be very transparent and to mimic an index. It can also be traded all day like stocks. The advantage of an ETF in your overall asset allocation is we know what index that we’re getting out of the investment.

Because we can study the index upon which an ETF was built, we are in luck. Although we cannot predict the future, we do have a very high degree of certainty around index construction and how decisions will be made in future.

Now, let’s talk about mutual funds

Unlike ETFs, a mutual fund is a pool of investments that trades at the market close every day, meaning you only buy and sell a mutual fund once a day.

A mutual fund is also highly liquid — but not as liquid as an ETF — and can be managed based on an investment manager’s prerogative or an index depending on the fund’s construction.

Why are ETFs and mutual funds grouped together?

When ETFs were first introduced, they were described as mutual funds that traded like stocks all through the market day. Like bonds, here we are dealing with yet another incomplete definition that, at a surface level, is somewhat a true statement.

Are ETFs and mutual funds somewhat similar? Sure, you could say that. And they are often used similarly in a portfolio. But it’s important to understand what makes them different (particularly in how they are traded), and that ETFs and mutual funds are not interchangeable terms for the same type of investment.

Like bonds, this is only scratching the surface of what I’d love to talk with you about, on the topic of ETFs and mutual funds. But if we want to get you to the next type of investment before supper time, I’ll have to save those thoughts for another day.

Investment #4: Annuities

The last investment type we’re going to examine are annuities, which is somewhat tricky, in terms of how we define it. Annuities are very misunderstood, with entire books written about them alone. But we’re going to do our best here to give you a basic definition of what they are, for the purposes of today’s conversation.

The legal understanding of what an annuity is, is that it’s an insurance product. The practical understanding, however, is that it is often looked at as an investment with an insurance wrapper. Meaning it is typically an investment that offers investors some type of guarantee.

The most common guarantees you will see with annuities are are:

an investment in some type of market sub-account (yet with no losses)
an investment with a fixed interest rate
an investment with a fixed income for a period of time or for life
an investment with a death benefit to your heirs

… or some combination of two of the four above guarantees.

Annuities are good investments that should provide a guarantee that helps you achieve your financial goals. But I would be remiss if I didn’t mention what many of you may already know — annuities have a bad reputation. Not because of the principles behind what an annuity is, but rather due to unethical salespeople in the field.

To be clear, just as not all dogs are labradors, not all folks who want to sell annuities to you are unethical.

These are the tools for your financial future

Stocks, bonds, ETFs, mutual funds, and annuities … these are the building blocks of your financial future. Are they complex creatures with far more nuances and complexities than I was able to share with you today? Yes. But this base level understanding is meant to help you get pointed in the right direction.

To reach your financial goals, you must become fluent in these different investing tools — or hire a financial advisor or investment manager who can understand them on your behalf. If you decide to go the route of hiring someone, keep in mind that you are still the artist behind your own masterpiece. Meaning your goals and your vision for what you want to achieve is what will help your financial partner set your strategy.

Moreover, remember these different types of investments are simply tools to help you achieve whatever greatness or freedom looks like to you. They are a means to an end, so don’t fall in love with them. Some of you may be laughing at that last time, but I am serious! Folks fall in love with their investments all the time. For instance, there are those who are enamored by the elegance of Tesla and may cling to those investments no matter how those tides may change.

You can develop emotional connections of what you think your investments will do for you and what they will mean to your success — but that doesn’t always mesh with reality, and it can cloud your vision of what’s truly important.