Diversifying a portfolio across different types of investments, or asset classes, can help you manage its risk and return potential. While there are a wide variety of investment types, understanding these four commonly used ones can be helpful:
Stocks are bought and sold in shares that trade on an exchange, and when you invest in one, you become a part owner of the company.
Investors usually buy a stock because they think the company will be successful. If they're correct, the stock will likely increase in value, and they may be able to sell it at a profit. In addition, investors can profit if the company pays out part of its profits as a cash dividend.
Since stock prices fluctuate, you may actually lose money. So, before you buy a stock, you may try following financial news; using market indices such as the Dow Jones Industrial Average, S&P 500, and NASDAQ Composite to watch trends; and thoroughly researching companies you're interested in.
When you purchase a bond, you're lending money to the issuer. Government entities and corporations issue bonds, and in return, they promise to pay interest to the bond holders.
Treasury securities are considered low risk because they're backed by the U.S. government. Municipal and corporate bonds, on the other hand, have greater potential risk. You should research the issuer before you buy to assess whether it can repay the loan.
Bond investors face a variety of risks, including rising interest rates, which reduce the value of existing bonds, and the possibility the issuer will default and fail to pay investors interest or principal when they're due.
Rather than buying an individual stock or bond, you might want to invest in a mutual fund, which is a professionally managed collection of investments. The fund manager decides which investments to buy, sell, or hold for everyone who owns fund shares.
Some mutual funds are higher risk than others, and no fund is a sure thing. But because they invest in a variety of stocks, bonds, or other products, mutual funds make it easier to diversify your investments across a number of companies and market sectors.
Mutual fund shares can be redeemed at the end of the day at what's called their net asset value, or NAV. Keep in mind the fund manager charges investors a fee, and you may have to pay a sales charge known as a load.
An ETF holds a basket of assets. When you purchase an ETF, you buy shares of the overall fund rather than shares of the individual investments within the basket.
Some ETFs are designed to track the performance of a specific index, sector, or commodity and are not actively managed. Others are actively managed, meaning the manager buys and sells investments within the fund. Unlike mutual funds, ETFs trade on an exchange so they can be bought and sold during the day.
ETFs carry the risk of their underlying investments, and there's no guarantee they will meet their stated objectives.
Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates.
Exchange Traded Funds seek investment results that, before expenses, generally correspond to the price and yield of a particular index. There is no assurance that the price and yield performance of the index can be fully matched. Exchange Traded Funds are subject to risks similar to those of stocks. Investment returns may fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost.