Types of investments: Breaking down the basics

Even if you know you should invest, choosing the right types of investments and learning all the ways to invest can seem like a real head-scratcher.

One of the most important lessons to learn might sound really obvious: Investing is different from saving. Saving involves putting your money in a savings account, in a money market fund or even under your mattress, but it doesn't give your cash a lot of room to grow. Investing gives you the opportunity to take a few more risks with your money because it has more earning potential and is one of the best ways to beat inflation and take advantage of compounding. (Compound interest occurs when your interest makes money off of interest.)

So, where do you start with investing, and which types of investments make the most sense for your portfolio? In this article, we'll go over five popular investment choices and walk through how you can purchase these types of investments.

Let's walk through five investment types you may want to consider. We'll take a look at characteristics of each type of investment and help you decide whether this investment type will fit your portfolio.

A stock represents a small portion of ownership in a company. When you purchase a stock, you buy a tiny slice of that company's earnings and assets. Companies sell shares of stock to raise cash. Stocks sometimes earn high returns, but they can also invite more risk than other investments.

Why is that?

When you invest in the stock of one company, you invest solely in that single company rather than in multiple companies, as you would with mutual funds.

Some stocks also pay dividends, which are regular distributions of a company’s earnings to investors. That's one way you can make money on stocks. Otherwise, you can make money based on the regular increase of stock price.

Think you might want to invest in stocks? Learn how the pros and cons stack up:

Anyone can invest in stocks — they can be particularly attractive to long-term investors who are willing to take on a certain amount of risk. Certain stocks are riskier than others, so it's important to review the underlying factors of each company you invest in, such as company size, leadership, the company's balance sheet, volatility and dividend history.

Are there more types of bonds? Of course! Do your research to choose which one works best for you.

Since bonds offer lower risk, you want to assess your comfort level with bonds. If you have a longer time horizon, you might find a stock-heavy portfolio to be more friendly rather than a bond-heavy portfolio because you have time on your side. Investing in a less risk-averse portfolio may not allow you to benefit from compound interest quite as rapidly. On the other hand, if you’re getting closer to retirement age, you may want to pepper your portfolio with bonds because you may need to create lasting funds in retirement.

Mutual funds, which are professionally managed investment funds, pool money from many investors. Investors can purchase a wide variety of bonds, stocks and other types of securities. Bond mutual funds, for example, only invest in bonds. Due to compound interest, your mutual fund will rise in value over time, particularly if you have a long investment time horizon.

Mutual funds are some of the most popular types of investment accounts, though they do come with their own set of pros and cons. Take a look:

New investors, who may not want to worry about putting together a diversified investment plan, might find mutual funds to be a good way to dip their toes into investing.

How do you know whether a mutual fund is a good choice for you? If you want an opportunity to invest but feel more comfortable with a professional choosing the contents of your portfolio, you may want to consider a mutual fund. Mutual funds can also be a great alternative for those who plan to invest for a number of years, including for retirement purposes.

Index funds are a type of mutual fund or exchange-traded fund (ETF) that match or track a market index. For example, an index fund may follow a benchmark index, such as the S&P 500 or the Nasdaq 100.

They are a popular type of investment because you can tap into a diversified bundle of stock or mutual fund choices without having to pay the extra costs associated with a mutual fund, and you can make money from an index fund by earning returns. They’re designed to track an underlying stock market index, which can help you avoid losses.

Index funds pose risk just like any other type of investment, but because they offer diversification, your risk may be a little more tempered. Anyone can invest in index funds, but those who have a little time on their side might find them to be a better fit.

An exchange-traded fund (ETF) tracks an index, sector, commodity or other asset, but you can purchase or sell it on a stock exchange just like a regular stock. The benefit to this is that you can execute your trade at any time of the day, which means you can buy and sell at that exact time — not at the end of the day like a mutual fund.

You can choose from lots of different types of ETFs, including index ETFs, actively managed ETFs, bond ETFs, commodity ETFs, sector ETFs, foreign market ETFs and more.

You might consider ETFs if you’re a beginner investor, an investor who wants to track an index or an investor who want to actively trade ETFs. ETFs invite risk but examining the underlying factors for all ETFs you’re considering can give you a great basis for a wise purchase.

How do you purchase different types of investments?

Great question. You may not have a lot of time on your hands, so your first question when you’re learning about investing might be about whether you can set up a brokerage account quickly? The answer is yes. In most cases, you can set up an online brokerage account in a matter of minutes, although it depends on the brokerage.

Once you enter your basic information, such as your name and email address, and create a username and password, you’ll need to link your bank account to your new brokerage account, which means you’ll have to initiate a deposit or funds transfer. A brokerage will typically deposit a couple of pennies into your account, and you’ll have to confirm how much the broker deposited.

Once you’re linked, you can start investing! Most brokerages have made it simple to get started, with explainers, glossaries and easy-to-access help on each website.

When you want to get started investing, pat yourself on the back. There’s no better feeling than taking control of your finances and putting yourself on a great path toward financial security. If you’re still not sure about the right type of investments for you, you could try a diverse combination of investment types, like the ones we’ve mentioned above.

It’s worth noting that there are lots of other ways you can invest your money, including stock options, forex and futures. However, some of these riskier (and more advanced) types of investments might better serve you once you get comfortable with the basics of long-term investing. Many experts recommend learning about trading options for beginners once you’re settled in your investing journey.

Choosing your investments and determining the types of investing that fit you is a very personal decision — that’s why it’s called personal finance!