If you are a first-time investor, one of the things you’ll want to consider is the relative safety of different investment options.
You can choose to put your money into many different kinds of investments, all of which involve different levels of risk. Real estate is the most common kind of investment. A house is typically a safe investment, because house prices tend to rise over the long run. Multi-unit residential and commercial buildings are a bit riskier, since vacancy rates vary with the local business and housing economy.
Commodities like oil, gold and agricultural products are another, much riskier, kind of investment. The markets for commodities go through boom-and-bust cycles, and prices can fluctuate wildly. Therefore the risk that you will lose money you invest in commodities is relatively high—as is the possibility you will earn a high return. Investing in commodities is not for beginners, because of the level of risk, the minimum amount of investment capital required and the complexity of trading futures.
Financial products are the second most common kind of investment, after real property. There are financial products suited to every pocketbook and level of risk tolerance. They include mutual funds, stocks and bonds and certificates of deposit.
All these products fall into one of three basic asset classes: cash, equities and fixed-income investments.
Cash investments include savings accounts and treasury bills. Typically, cash investments carry a very low risk. They also pay low, but stable, returns to investors.
Equities (often referred to as "stocks") include investments in the common and preferred shares of companies. Investors buy equities primarily for growth. As a general rule, they offer greater potential returns on investment than cash or fixed-income investments and carry a higher degree of risk. Nevertheless, the shares of large, well-known companies that trade on public stock exchanges are generally a safer investment than the shares of small private companies and start-up companies.
The nature of the company’s business, as well as its financial position, has a bearing on how risky it is as an investment: shares in large public oil exploration and gold mining companies tend to be more volatile in price than those of large financial institutions, for example.
Companies that do business in politically unstable countries, poor countries and countries with fluctuating currency are also considered riskier investments than those located in the U.S., Canada, Britain and other developed countries with stable economies and political structures.
Fixed-income investments include certificates of deposit or term deposits, corporate and government bonds and fixed-rate, dividend-paying shares. As a rule, fixed-income investments fall between cash investments and equities in terms of both risks and rewards. But as with equities, the risk varies. Bonds of companies that have a high level of corporate debt can be riskier to invest in than both the bonds and the equities of large, financially stable companies.
Mutual funds are another very common financial product. Generally, investing in a mutual fund involves less risk than investing directly in corporate securities. Since a fund owns the stocks or bonds of many companies, and possibly governments, bad performance of one investment is usually counterbalanced by the good performance of others.
Mutual funds come in many flavors, but generally fall into one of three categories:
- Equity funds, which invest mainly in the stocks of publicly traded companies and focus on creating capital gains.
- Fixed-income funds, which invest mainly in bonds and dividend-bearing shares, and focus on generating a steady stream of income while preserving capital.
- Balanced funds, which contain a mixture of stocks, bonds and other securities and try to generate capital gains while preserving capital.
Equity funds are generally considered riskiest, fixed-income funds safest, and balanced funds, somewhere in between. But mutual funds must be risk-rated individually. The style of the fund manager, the kind of businesses the fund specializes in and the part of the world in which it invests are a few of the factors that determine the risk involved in a particular mutual fund. A fixed-income fund that specializes in bonds of distressed companies, for instance, may carry a greater degree of risk than a growth fund that specializes in the stocks of big banks and other blue-chip companies.
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