As a physician, you’re in the upper echelon of society and your salary is designed to match your years of expertise. You invested in your education by making sacrifices in your social life and taking out student loans, but what do you do once you start earning the big bucks?
Investing is the key to getting your money to work for you, but not all types of investments fit every person.
Understanding the different types of investments and how they work can help you unlock your full earning potential.
Understanding Different Types Of Investments
While there are virtually endless types of investments to consider, many investments can be categorized under the four main asset classes.
- Equities (stocks)
- Fixed Income (debt/bonds)
- Cash and Cash Equivalents
- Real Estate and Commodities
In this article, we’ll dive into asset classes with examples of the different types of investments that define each category.
Equity investments are shares of stocks in a publicly traded company. When you purchase an equity investment, those shares of stocks can then be traded on the market.
With that said, there are subcategories of stocks.
Common Stock vs. Preferred Stock
Common stock and preferred stock are two classes of stocks. They are similar. Common and preferred stock values fluctuate with the company’s earnings.
Preferred stocks pay dividends, have the first “right” to dividends when called, and have an agreed-upon cadence. Common stock may or may not pay dividends, depending on the company’s financials.
As interest rates rise, preferred stocks can lose their value as their dividend has less purchasing power and competitiveness than before.
Preferred stocks are great for investors who need a stable income stream when interest rates are low and do not require voting rights on the company. If held to maturity, you will receive the entire value like a bond.
US Equity Large Cap
Large-cap stocks are for companies with more than $10 billion market capitalization. These large firms typically have a history of paying dividends and steady growth. The brand names are recognizable and may be household names.
Large-cap equities are considered conservative compared to investing in small or mid-cap equities. The returns of large-cap equities are typically lower, but their risk is also typically lower.
- Johnson & Johnson
You can find large-cap stocks in the leading benchmark indexes such as the S&P 500, the Dow Jones Industrial Average, and the Nasdaq Composite.
US Equity Mid Cap
Mid-cap stocks are issued by companies with market values between $2 and $10 billion.
Mid-size firms grow quickly and have the potential to become large-cap firms.
The risk and returns of mid-cap equities typically fall between small and large-cap equities. They usually provide a nice mix of growth and stability.
US Equity Small Cap
Small-cap stocks are for companies with a market value of under $2 billion. Their size places them in between mid- and micro-cap equities.
These small firms are newly established and growing quickly. The risk and returns of small-cap equities are typically much higher than large-cap equities.
Because these small-cap equities have smaller market capitalization, there isn’t as much for investors to purchase. Mutual funds are limited in buying small-cap equities because they can’t hold a majority share in a company.
Non-US Equity Developed
International equities, just like international bonds, are grouped by the stage of development of a country, either developed or emerging.
Non-US equities from developed countries are considered a less risky investment than those from emerging countries; however, they carry currency risk, also known as exchange-rate risk.
Non-US Equity Emerging
Emerging market equities typically offer higher returns but come at a higher risk than non-US equities from developed countries.
Not only do non-US equities from emerging countries have currency risk, but they are also at a higher risk of default and extreme volatility.
When investing in non-US equities from emerging countries, ensure that it’s a small percentage of your overall portfolio asset allocation to limit your exposure to the high level of risk these equities pose.
Exchange-Traded Funds and Mutual Funds
Exchange-traded funds (ETFs) and mutual funds are collections of many stocks or bonds. These funds allow investors to diversify the risk of being too heavily concentrated in one company.
They typically invest in companies based on the purpose of the fund. For example, an ETF for large-cap growth stocks would only invest in large-cap growth stocks.
ETFs can be bought and sold like a stock, whereas a mutual fund typically sells at the end of the trading day based on the closing price.
Mutual funds are actively managed and often have higher fees and expense ratios to compensate the portfolio manager. ETFs are usually passively managed, but they can offer lower fees and expense ratios due to their lower overhead costs.
2. Fixed Income (Bonds)
Fixed-income investments are an asset class for any type of investment that pays guaranteed interest or dividends until it reaches maturity.
Bonds are a common type of fixed-income investment, but certain savings accounts, like Certificates of Deposits, can be considered a fixed-income investment in some cases.
Discount or Premium Bonds
When purchasing a bond, the amount you pay dictates if you bought it at a discount or a premium. To determine which, just compare the amount you paid to its face value, the amount you receive back at the end of its term.
For example, a $1,000 face-value bond sells for $900. This bond was sold at a discount, and if it doesn’t pay any interest through a coupon payment, then the rate of return is based on the $100 difference, accounting for the time to maturity.
If you purchased this bond for $900 and it pays interest every year, then your rate of return will be higher than the coupon rate because you will receive interest every year plus the $100 difference at its maturity.
However, if that same bond is sold for $1,000, the same amount as its face value, then the rate of return is equal to the coupon rate or annual interest.
When you purchase a bond for less than its face value, you buy it at a discount. When you purchase a bond at its face value, your rate of return is equal to the coupon rate.
Purchasing a bond for more than its face value is considered a premium.
Government Securities and Corporate Bonds
Municipal bonds, or muni bonds, are securities of state and local governments issued to fund local projects.
Municipal bonds are a fundraising endeavor the government uses to follow through on necessary infrastructure. Local governments use muni bonds to pay for highways, new schools, and bridges.
Municipal bonds are highly secure and can be used to fortify your investment portfolio against recession under the right circumstances.
US Corporate Bonds Core
This group of corporate bonds offers investors access to a bond fund product with diversified exposure. Their design provides diversification on the maturities and investment grades of many bonds.
These funds can be active or passive, meaning someone could be actively managing it and making frequent trades or it could follow the performance of a given index.
We recommend all interested investors research the fund and its managers before buying into a US corporate bond core fund. Qualified financial advisors won’t beat around the bush when you ask them questions.
US Corporate Bonds Long Duration
Long-duration bonds have a duration of more than ten years to maturity. These bonds typically have higher interest rates compared to shorter-duration bonds.
As with other bonds, your income and principal are relatively safe. However, long-duration bonds are considered riskier because of the risk that inflation will reduce the purchasing power of the bond over such a long time.
US Corporate Bonds High Yield
US corporate high-yield bonds offer higher yields than other bonds, meaning you receive a higher interest rate. However, these bonds typically also have a higher risk of default and are often called “junk bonds.”
When companies can’t obtain a higher investment-grade rating for their bonds, they need to pay a higher interest rate to entice investors looking for a higher reward. High-yield bonds carry a bond rating of BB or lower.
Companies that can’t obtain an investment-grade rating aren’t necessarily bad. Many smaller or emerging companies, like start-ups, may not get this high rating and may resort to issuing a high-yield bond.
However, if a larger or more established company offers these “junk bonds,“ they may be highly leveraged or experiencing financial difficulties.
Non-US Debt Developed
International bonds accounted for 35% of the world’s investable assets, according to a 2012 Vanguard study. International bonds are grouped by a country’s development stage, either developed or emerging.
Non-US bonds from developed countries are considered a less risky investment than non-US bonds from emerging countries; however, they are not without risk.
When investing in non-US debt, developed or emerging, currency risk is an important consideration. Bond issues may hedge currency risk against the forex market and derivatives like futures and options, which can make them riskier investments.
Non-US Debt Emerging
Emerging market bonds are a small but growing segment of the overall market. These securities typically offer higher returns and yields but come at a higher default risk than non-US bonds from developed countries.
Interestingly, according to a 2018 Vanguard study, emerging market bonds “performed more like equities than bonds.”
In the same Vanguard study, they found that 68% of the total emerging market bonds came from 10 of the larger emerging countries, including:
- 13.8% in Brazil
- 10.3% in Mexico
- 9.7% in China
- 6.4% in Indonesia
- 5.7% in Russia
- 5.0% in Poland
- 5.0% in Turkey
- 4.2% in South Africa
- 3.5% in Colombia
- 2.5% in Thailand
Because of the nature of these bonds, they typically fall into the same group as US corporate high-yield bonds.
3. Cash and Cash Equivalents
Cash and cash equivalents include liquid assets, such as actual cash, not invested cash, and liquid investments, such as money in a money market account.
Cash equivalents are a tiny percentage of a portfolio–1% to 2% maximum until you retire.
Once in retirement, it’s common to see 3 to 5% in cash or cash equivalents to make it easier to access without having to sell to access your new income source.
People generally don’t invest much in cash or cash equivalents because they don’t allow the money to grow as much as other securities.
- US Government Treasury Bills:
- Bank Certificates of Deposit (CDs)
- Bankers’ Acceptances
- Corporate Commercial Paper
- Money Market Instruments
4. Real Estate and Commodities
The average rate of return on real estate is 8.6%. When you compare that growth to your savings account, the value of real estate is clear.
You can invest in real estate by buying a rental property, making improvements to increase your home’s value, paying down your mortgage, or refinancing to cash in on your home’s equity.
You can also invest in real estate investment trusts (REITs), companies that own or finance income-producing real estate. These securities provide many of the financial benefits of real estate investing without the hassle of managing properties.
REITs can be publicly traded on an exchange or non-traded.
Investing in gold, art, and other commodities can give you tangible assets to enjoy and a less abstract investing strategy than the stock market. It can also be an excellent way to diversify your portfolio if you’ve already invested in stocks, bonds, and mutual funds.
Gold can also be a great way to pass on generational wealth to your children and loved ones because it retains its value well over time.
Let’s consider an example of how gold can preserve wealth. Imagine you have a $20 bill. You can purchase $20 worth of gold and hold onto that, or you could stow the $20 bill away.
When you buy gold at the current price, you can see that value grow through inflation and other market conditions. When you hold onto that $20 bill, it may become devalued through inflation and a loss of purchasing power.
In other words, that $20 may not be able to purchase the same amount of gold later. Investing in gold and other appreciating assets allows you to let your money grow without trading on the stock exchange.
How to Buy Different Types of Investments
You can begin dabbling in investing in a few different ways. You may even choose a hybrid approach to managing your investments.
We’ve outlined the different approaches to investing, so you can choose the approach that best fits your needs.
Do It Yourself
You can educate yourself on the different types of investments, develop your own strategy, and open a brokerage account. Managing your investments on your own gives you autonomy and the ability to get up and running quickly, but it can carry more risk if you lack experience.
With that said, it can also save you more money in the long run because you won’t have to worry about management fees. With this approach, you’ll need to be particularly mindful of capital gains when you trade because investment income carries tax liability.
If you don’t have the time, expertise, or emotional fortitude to manage your own investments, outsourcing can be a wise solution. However, it often comes at the expense of giving the firm a percentage of all the assets they manage for you.
While it is a more expensive option and it requires a lot of trust in others, the ability to grow your investments strategically and access professional insight makes this cost worth it for many investors.
You can vet financial advisors and their firms on FINRA’s BrokerCheck and the SEC’s Action Look-Up tool. Both databases keep a record of registered financial professionals’ credentials and any disciplinary actions taken against them.
In recent years, algorithm updates and the surge of AI have ushered in new investment management tools. RoboAdvisors, like Betterment, Acorns, and Ellevest, have disrupted the expense of portfolio management.
You can download Robo advisor apps to evaluate your risk tolerance and begin making the best investments that align with your interests and values.
Apps tend to charge a small monthly or yearly fee for beginner investors, but they may charge more if you have a significant amount of money invested with them.
Like financial advisors, RoboAdvisors can help you open an individual retirement account (IRA) in addition to purchasing shares of stocks, bonds, and other assets.
Frequently Asked Questions
What types of investments can be considered risky?
All investment options carry some level of risk, and your risk tolerance is unique to your assets and financial goals. With that said, some types of investments carry more risk than others.
- Alternative investments (art, collectibles, cryptocurrency)
- Emerging markets
- Futures contracts
- High-yield savings bond
- Initial public offerings (IPOs)
- Limited partnerships
- Oil and Gas
- Penny stocks
These investment products tend to carry more risk because they fluctuate unpredictably and require a lot of mental energy to manage. Low-risk investments tend to follow more predictable patterns based on past performance.
What types of investments pay large returns?
The types of investments that pay large returns include:
- Index funds
- Money market accounts
- Individual stocks
However, this list isn’t all-encompassing, so discussing your options with a qualified financial professional and honing your knowledge of the market is important.
Your rate of return will depend on the specific investments you make, and many nuances, including risk management, make a particular investment a good fit for your portfolio.
What types of investments are the most liquid?
Cash and cash equivalents are the most liquid types of investments. You can also quickly liquidate marketable securities (stocks and bonds), short-term government bonds, mutual funds, and ETFs.
What is the difference between bonds and stocks?
A stock is a share in a public company. When you buy stocks, you purchase shares in a publicly traded company.
These companies put their company shares into the stock market and divide them so that individual investors, you, can go in and buy shares of that company. These shares are worth more or less based on how the company performs and how others value the company.
When you buy a bond you buy debt from a company or government. Your investment is a loan to the company.
Let’s say Walmart puts out a corporate bond. When investors buy the bond, the company uses the money. Later, the company returns the principal plus the interest payment originally outlined.
It’s not just companies with debt; the federal government also has debt you can purchase. These are referred to as Treasury or T bills.
Investing is a personal endeavor, which means there will always be nuances based on your unique situation. The best thing you can do is educate yourself on the different types of investments and start gaining experience.
If you’re relatively new to investing, partnering with a fee-only financial advisor or a RoboAdvisor can be a cost-effective method to get your feet wet. Some financial advisors even specialize in medical professionals’ and physicians’ needs.
Seasoned investors can self-manage or choose the method that works best for their investing style to add different types of investments to their portfolios.
All investments have risk, so you should take an honest inventory of your assets, goals, and values to determine your tolerance before you play the market. The right investments can fortify your long-term financial security, but the wrong investments can be akin to a gamble.
Developing a system you can trust can help you command the different types of investments and harness their power to work for you.