Investing for Beginners: Basic Investment Terminology

You own part of the company (aka a share in the company). The price of that share can fluctuate given what people think the company is worth (or will be worth) and what they are willing to pay for a share.
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Welcome to Part 1 of our Investing for Beginners series. In this post, I'll break down some of the common terms you might hear when it comes to investing. What is a mutual fund, REIT or ETF? How might those things fit into my investment strategy? Next week I'll examine some of the criteria I use when selecting such investments. These are the types of investments you might hold in an investment account such as a 401(k), IRA or brokerage account.

Stocks - You own part of the company (aka a share in the company). The price of that share can fluctuate given what people think the company is worth (or will be worth) and what they are willing to pay for a share.

Bonds -- This is an IOU from a company or municipality. You lend them money in the form of purchasing their bond and they owe you back according to the terms of the contract. Sometimes owning individual bonds can have advantages. This is something I only recommend if you have enough money to buy a variety of different bonds. If not, a bond mutual fund (which we'll get to in a moment) will give you the diversity of investments that trumps the advantages of individual holdings.

Alternative Investments -- Real estate, art, commodities (like gold) and hedge funds are all examples of alternative investments. However, hedge funds lack the transparency of other types of investments and are generally not available to investors unless they have a fairly large net worth. The other types can be a great diversifier in anyone's portfolio. You can purchase them in the form of a mutual fund or ETF (I'll get to their descriptions momentarily) that specialize in an alternative investment. You could also hold them privately, in the case of a rental property, for example.

Mutual Funds -- These are funds that own a group of stocks, bonds or other investments. In the case of blended funds, it can be a combination. There are thousands and thousands of mutual funds available for purchase. Some cover certain geographic areas, while others hold companies of a certain size (such as small, mid or large cap).

Exchange Traded Funds (ETFs) -- These funds act similarly to mutual funds with a few key differences. They tend to be indexed, but that is changing too. These investments have experienced a dramatic increase in the amount invested and funds offered in the past decade.

Real Estate Investment Trust -- Known as REITS, tend to be illiquid and have high investment minimums. They are also required to pay 90 percent of their income each year which can be appealing, but can also pose tax considerations. Fortunately, for accessibility and simplification, you can purchase real estate in the form of mutual funds and ETFs that own REITs and other real estate investments.

Annuities -- Just like the other categories, not all annuities are created equal. There are variable, deferred and fixed annuities. These are generally products I'd recommend for retirees who need income. An immediate, fixed annuity can provide an income stream. With traditional pensions becoming a thing of the past, this can serve an important need for retirees. Annuities can have tax benefits, but also tend to charge higher fees, which can eat away at returns considerably over time. They are also illiquid which is a potential disadvantage.

This is just an overview to help you get an idea about several different types of investments. When I work with clients, we build a diversified portfolio with some of these building blocks. Investopedia is a resource that goes into greater detail on defining and explaining each of these investments in addition to many other topics. Entire careers have been based on subsets of each of these investments, so this post is an introduction and in no way exhaustive.

Stay tuned for next week's post to learn more about the criteria I use when selecting investments so that you can SaveUp!

This post was written by SaveUp's personal finance contributing writer, Catherine Hawley, CFP®.

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