Everyone knows that the easiest way to make money is to get a stable job to earn an income. But the problem with relying solely on employment income is that it doesn’t take the future into consideration. Even if you’re good at putting aside a small fraction of your income into savings, that money may lose its value over time thanks to fluctuations in the economy (i.e., inflation).
Maybe you are interested in supplementing your employment income with something more passive, or maybe you want to set yourself up with more financial freedom in the future. Luckily there are several ways in which you can future-proof your money and increase its value over time. This is done through investing.
What is investing?
Investing is the process of purchasing some sort of asset (a thing of value) that has a tendency to increase in value over time. In some cases, you can even make a living through investments alone, but this requires years of expertise, a lot of knowledge and a little bit of luck.
There are several types of investments — otherwise known as securities or asset classes — to choose from. These range from real estate to stocks, and to new digital assets such as cryptocurrencies. So, what exactly are the various investments that you can make today?
Types of investments
Arguably the most well-known type of investment is in stocks. Stocks are publicly traded assets of a specific company. By owning a stock, you essentially own a portion of that company and are entitled to a share of that company’s earnings. Investing in a company’s stock assumes that the company will increase in performance over time.
Public stocks are traded on stock exchanges. In order to access stock exchanges, you must first sign up with a stockbroker which acts as the bridge between traders and the stock market. There are several online stock brokers to choose from and signing up is easy. These days, most stockbrokers even have apps that you can download on your smartphone for on-the-go trading.
Similar to stocks, bonds are ways for investors to capitalize on the financial actions of corporate and government entities. The difference is that instead of buying shares proportional to the value of a company, owners of bonds are investing in debt generated by some entity borrowing money. Governments, municipalities, and corporations often borrow money from banks in order to fund projects. Borrowing money creates debt owed to the lender, so owning a bond means that you are entitled to some portion of the debt owed.
Bondholders earn money by gaining interest on payments owed by the due date. For this reason, bonds are known as fixed-income securities, because payment is guaranteed over a fixed period of time. Since bonds offer consistent returns, they are generally seen as low-risk investments. Bonds also offer a lower return on investment than stocks.
3. Mutual Funds
If you’re interested in security investments but don’t have the time to micromanage them, then mutual funds are the way to go. Mutual funds are professionally managed collections of securities, also known as investment portfolios.
With mutual funds, portfolio managers are hired to analyze the market and make changes to your investment portfolio in order to maximize your capital gains. Having a professionally managed portfolio helps to diversify your investments, thus minimizing the risk involved. Diversification basically means investing in several different asset types so that one asset type won’t drastically affect your overall investment portfolio.
A single mutual fund could contain hundreds of securities. The money needed to buy a mutual fund is pooled from other investors, which reduces your initial buy-in costs. Your income from mutual funds is determined by the average performance of all the securities that comprise it.
4. Exchange-Traded Funds
Much like mutual funds, exchange-traded funds (ETFs) are collections of securities that are traded at a bulk price. However, unlike mutual funds, ETFs are traded publicly on stock exchanges. Like with individual stocks, ETFs have their own stock tickers and associated price tag.
If you’re looking for a cost-effective way to diversify your portfolio, ETFs are an excellent way to do so. ETFs can be purchased without the need of a portfolio manager, but the securities that comprise ETFs are still managed by someone who is attempting to maximize the gains of investors.
Another way to buy and sell securities is through Options trading. Options can be thought of as non-binding contracts that derive their price from the asset in question. Instead of owning the security directly, Options give a trader the choice of whether or not to buy or sell an asset at a specified price and date. Buying an Option is known as a “call”, and selling an Option is known as a “put”.
6. Futures / Commodities
Futures are very similar to Options in that they are a way to secure a proposed price of an asset for a future date. The difference is that Futures are binding, meaning that once initiated you must follow through with the purchase or sale of the asset. Another difference is that while Options require an initial deposit — or premium — to initiate the contract, Futures do not. The risk associated with Futures is higher due to its binding nature and the fact that a single Future contract holds more underlying value than an Option contract.
A Futures purchase is known as a “long” and a Futures sale is known as a “short”. By placing a long or short contract on an asset you are essentially betting on the price increasing or decreasing by a specific date.
Additionally, the trading of commodities can be carried out through Futures contracts. Commodities are the fundamental resources that are used to make other goods. Examples are oil, electricity, and precious metals. All commodities are unique in that they’re interchangeable no matter the producer, as opposed to manufactured goods like cars and smartphones. When ordering a Futures contract you are buying or selling some amount of the actual commodity.
7. Real Estate
One of the most potentially lucrative forms of investing is in real estate. Real estate is the purchase of a physical space such as a home, land, or building. Demand for real estate comes from the fact that it is a limited resource and people will always have a use for physical space. Investing in real estate is also appealing because oftentimes you don’t even need to pay the full price of the asset, to begin with, just the initial deposit. This is known as leverage.
One way to invest in real estate is by purchasing houses in up-and-coming neighborhoods, or remodeling a home and then reselling it at a higher price than what you purchased it for. Another way is to become a landlord that rents spaces out to people temporarily. In this way, real estate becomes a source of passive income while you remain in charge of maintenance and improvements.
8. Retirement Plans
Anyone who’s landed a full-time job has probably been offered some sort of retirement package along with it. Retirement plans incentivize people to stay in the workforce longer in order to compound their income and receive a large payout upon retirement.
Have you ever heard of a 401(k)? This is a popular retirement model where the company that you work for contributes their own money towards your retirement savings. The longer you work for that company, the more money they will contribute. If you keep to your employer’s retirement policies, you’ll be able to withdraw the full amount with minimal penalties when you retire.
9. Certificate of Deposit
Similar in practice to retirement plans are Certificates of Deposit (CDs). The purpose of a CD is to make a deposit into the account and not withdraw from it for as long as possible. CDs differ from normal savings accounts, however, in that they earn high, fixed interest for as long as your funds remain in the account for the specified term length. For better or for worse, CDs are designed to be extremely hard to withdraw from unless you wish to incur large penalties. Contrary to retirement plans, CDs are generally designed with term lengths ranging from a few months to a few years.
Last but not least is one of the newest asset classes to hit the markets. Cryptocurrencies are a digital store of value that can be exchanged for fiat currencies like the dollar or euro. They’re digitally programmed on top of decentralized software ledgers called blockchains that keep track of every transaction cryptographically. This means that every transaction is verifiable by the public, but the identity of the individual parties involved remain anonymous. Being decentralized also means that no single entity, such as a central bank, controls these assets.
Some retailers currently accept cryptocurrencies as a valid payment method, with more companies jumping on board all the time. Value for cryptocurrencies comes from their alleged use-cases as well as general speculation. Cryptocurrencies are bought and sold on public crypto-exchanges in much the same fashion as traditional stocks, but traditional stockbrokers are gradually warming up to them as well. If you’re tech-savvy and okay with investing in high-risk assets, cryptocurrencies may be a lucrative addition to your investment portfolio.
Risks associated with investing
All investment types have some risk associated with them, whether the risk is low or high. Risks come in many forms and vary among investment types. In general, it is advised that you do not invest in risky assets unless you are prepared to lose a lot of money.
Many investment strategies are built upon the speculative nature of future value. It is nearly impossible to know for certain when and if an asset’s value will increase or decrease.
No one was able to accurately predict that the housing market would crash causing the economic recession of 2008. This recession had cascading effects all across the economy, and many people lost fortunes.
What is known, however, is that some investments carry a lower risk than others. Retirement plans, CDs, and bonds are generally seen as low risk, while stocks and cryptocurrencies can be extremely high risks. For this reason, it is of utmost importance to know the risk associated with a potential investment.