You can invest in any or all three investment types directly or indirectly by buying mutual funds. Another option is to invest in tax-deferred options, such as an IRA or annuity.
When you invest in stocks, you’re buying a share of ownership in a corporation. You’re a shareholder.
There are two types of stock:
- Common stock. Shareholders have a percentage of ownership, have the right to vote on issues affecting the company and may receive dividends.
- Preferred stock.
Investment returns and risks for both types of stocks vary, depending on factors such as the economy, political scene, the company's performance and other stock market factors.
When you buy a bond, you’re lending money to a company or governmental entity, such as a city, state or nation.
Bonds are issued for a set period of time during which interest payments are made to the bondholder.
The amount of these payments depends on the interest rate established by the issuer of the bond when the bond is issued.
This is called a coupon rate, which can be fixed or variable. At the end of the set period of time (maturity date), the bond issuer is required to repay the par, or face value, of the bond (the original loan amount).
Bonds are considered a more stable investment compared to stocks because they usually provide a steady flow of income.
But because they’re more stable, their long-term return probably will be less when compared to stocks. Bonds, however, can sometimes outperform a particular stock’s rate of return.
Keep in mind that bonds are subject to a number of investment risks including credit risk, repayment risk and interest rate risk.
Cash equivalent investments protect your original investment and let you have access to your money.
These different types of investments generally deliver a more stable rate of return. But cash equivalent investments aren’t designed for long-term investment goals such as retirement.
Warren Buffett: Investments, Insurance and The Economy (2017)
After taxes are paid, the rate of return is often so low that it doesn’t keep pace with inflation.