Types of Investments

Types of Investments

Investment broadly means buying something for future use so that it either creates a periodic cash inflow or its value rises over time and when sold in future fetches a value above the price at which it was bought i.e. capital gains. There are three broad types of investments- stocks, bonds and, cash equivalents and it is important to weigh in each type before investing.

Explanation

There are many ways of investing in each category of investments, as stated above. To choose from the above also is dependent on many factors. While stocks and bondsStocks And BondsA stock represents a collection of shares in a company, entitled to receive a fixed amount of dividend every financial year, mostly called equity. In contrast, bonds are associated with debt raised by the company from outsiders, which carry a fixed ratio of return each year.read more are suitable for long term growth and the cash equivalentsCash EquivalentsCash equivalents are highly liquid investments with a maturity period of three months or less that are available with no restrictions to be used for immediate need or use. These are short-term investments that are easy to sell in the public market..read more are suitable for investors who might prefer liquidity over long term growth.

Stock is an ownership instrument, while the bond is a lending instrument.

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Source: Types of Investments (wallstreetmojo.com)

Top 3 Types of Investments

As stated above, there are three types of investments that we shall discuss them as follows:

#1 – Stock Investments

Stocks are investments that enable the buyer to hold a portion of the Company’s assets and hence called ownership instruments. Companies issue such investments so as to raise capital. Stocks or share capitalShare CapitalShare capital refers to the funds raised by an organization by issuing the company's initial public offerings, common shares or preference stocks to the public. It appears as the owner's or shareholders' equity on the corporate balance sheet's liability side.read more come with more risk when compared to other types but earning potential is the highest.

The income is low when compared to bonds.

Advantages

• Liquidity of assetsLiquidity Of AssetsLiquidity shows the ease of converting the assets or the securities of the company into the cash. Liquidity is the ability of the firm to pay off the current liabilities with the current assets it possesses.read more
• Limited LiabilityLimited LiabilityLimited liability refers to that legal structure where the owners' or investors' personal assets are not at stake. Their accountability for business loss or debt doesn't exceed their capital investment in the company. It is applicable in partnership firms and limited liability companies.read more
• Right and Bonus shares
• Capital gains on buying and selling shares
• Control and ownership rights
• Voting rights

Disadvantages

• High Risk
• Limited Control
• No fixed dividend
• Residual claim on a dividendDividendDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company.read more
• Fluctuation in market prices

#2 – Bond Investments

Lending or loan investments allow the issuer of the investment to borrow the investors and pay back the same along with interest. They are a safer bet than the stocks to the investors because they offer definitive interest periodically.  The main risk in any instrument is the default risk, which is absent in case the amount is lent to the governments.

Advantages

• Fixed-rate of interest
• Lesser risk
• Tax benefitsTax BenefitsTax benefits refer to the credit that a business receives on its tax liability for complying with a norm proposed by the government. The advantage is either credited back to the company after paying its regular taxation amount or deducted when paying the tax liability in the first place.read more
• Helps in diversification

Disadvantages

• Interest rate riskInterest Rate RiskThe risk of an asset's value changing due to interest rate volatility is known as interest rate risk. It either makes the security non-competitive or makes it more valuable. read more and default risk
• Holders cannot be owners; they will always lend/creditors
• Periodical payment liability to the issuers
• If the rating falls down, it will be harder to liquidate

#3 – Cash Equivalents

These are investments that are meant exclusively for the purpose of short term holding and conversion into cash. That means they are highly liquid. They include money market instrumentsMoney Market InstrumentsThe money market is a market where institutions and traders trade short-term and open-ended funds. It enables borrowers to readily meet finance requirements through any financial asset that can be readily converted into money, providing an organization with a high level of liquidity and transferability.read more such as a certificate of deposits, commercial paper, etc. Cash and cash equivalentsCash And Cash EquivalentsCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation.  Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. read more in totality represent the strength of a company and its ability to pay off the current liabilities and debts.

Advantages

• Low risk of default
• Not dependent on market fluctuations
• Highly liquid
• Relatively safer when compared to other investment instruments
• Helps Company in meeting operating expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more

Disadvantages

• Lower rate of interest
• Loss of potential revenue due to keeping it idle to meet immediate needs
• These instruments struggle to keep up with inflation

Benefits of Investment

Investing is a very important activity that every entity and individual must do, and anything said about its importance would still be less to explain why it is so essential. That said, let us look into the main benefits of investment which throw some light:

#1 – Building of Wealth and Growth

The investors should find and chalk out a plan that suits them the best as per their earning capacity so that over time the amount invested grows, compounds, and builds in more wealth.

#2 – Fighting Inflation

If the amount is not invested, due to inflation, there is a decline in the purchasing power of money, and hence over a period of time, we tend to lose money. To prevent this from happening, we should invest money at a rate higher than the inflation rate in the economy.

#3 – Tax Reduction and Savings

A few investments like government bonds, local authority bonds offer tax deductions and hence result in savings.

#4 – Meeting Financial Goals and Objectives

Every entity, an individual, would have some goals and objectives about financial performance and wealth creation. Like an individual would have a goal to buy a house, a car, jewelry, etc. which would be possible only when there is money available to him in the form of investments.

#5 – Cash Inflows even when there are no earnings

Usually, there are times when there are no cash inflows such as unemployment or retirement in case of an individual and non-season for a business. At times like those, cash inflows from investments come handy.

Conclusion

An investor has a lot of options when it comes to where to put his money, which would yield benefits to him. There are various types of investments, as stated above, like instruments that give ownership rights, investments that make the holders, the lenders or creditors, and investments that are held so that they are cash alike or can be readily converted to cash whenever required.

Investments help in many ways, like fighting inflation, wealth creation, and meeting requirements. Each type has its own pros and cons, which have to be analyzed carefully as per individual investor requirements.

Recommended Articles

This has been a guide to Types of Investments. Here we discuss 3 types of investments with its advantages and disadvantages along with the benefits of investment. You can learn more about financing from the following articles –

• Brownfield Investment
• Investment Securities
• Greenfield Investment Definition
• Investment Partnership