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 bonds are suitable for long term growth and the cash equivalents are suitable for investors who might prefer liquidity over long term growth.
Stock is an ownership instrument, while the bond is a lending instrument.
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 capital 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 assets
- Limited Liability
- 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 dividend
- 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 benefits
- Helps in diversification
Disadvantages
- Interest rate risk 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 instruments such as a certificate of deposits, commercial paper, etc. Cash and cash equivalents 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 expenses
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 –
