What Types of Investments Are Best for You?

Which type of investment is best for you? Answering that question is like trying to answer, “Which tool is best for you? A hammer or a saw?” It’s impossible to choose without knowing what you want to accomplish. Choosing the best type of investment is easier if you see each option as a tool that can help you construct a specific outcome. Those outcomes often are shaped by how much time you do – or do not – have:

• Short term investing (3 years or less): Think “open a savings account,” not investing. To clarify: An investment is something you buy with money for the purpose of producing income or profit.
• Intermediate term investing (3-10 years): You can shift to investing but avoid the most volatile types, like individual stocks.
• Long term investing (10+ years): You can fully diversify, including riskier investments.

As you consider which type of investment is best for you, experts suggest you also think about how much risk you can tolerate and what your choice will cost you. Investments that lead to the highest rewards also generally are riskier and more expensive. Let’s look at some of the core investment options available.

If you’re going to need your money in three years or less, it may be better to think in terms of saving, rather than investing. Typically, the goal in such situations is to protect your money from the ups and downs of the markets. That’s because three years may not be enough time to recover losses. To guard against losing money, consider cash equivalents:

Online high yield savings accounts: You can open a savings account at virtually any bank, but online banks typically pay higher interest than their traditional counterparts. Higher is not that high, though – they only yield about 0.50% interest as of early 2022. But most of these accounts are FDIC insured, which means that even if the bank loses your money the government will replace up to $250,000 per account. And you can access your money at any time without penalty.

Certificate of deposit (CD): CDs are available at various terms, but they all require a deposit for a specified time period. At the end of that period, you get your principal back, plus interest. Generally, the longer your money is in the CD, the more you earn. For short-term deposits, like six months to a year, you’ll likely get between 0.10% and 0.20%. Like savings accounts, CDs are typically FDIC insured, so they are considered a safe investment, but you’ll likely pay a penalty if you withdraw your money early.

Even just a couple of extra years gives you enough time to shift your focus from saving to true investing. Still, 10 years isn’t always that long in investment terms. If you’re working in this time frame you may want to avoid the most volatile investments, such as stocks.

CDs with 5-year terms or longer: If you’re willing to keep your money in a CD for as long as five years, then you have the potential to earn around 0.50+% on top of your initial investment principal.

Short-terms bonds: Buying a bond is essentially lending money to a specific entity, such as the federal government, a municipality, or a corporation. At the end of a specific term, you get back your principal plus interest. Yields are typically comparable to CDs, and longer-term bonds pay more. Bonds are not risk free – they are not FDIC insured, and issuers could default – but they are considered safe investments.

Mutual funds: These allow you to buy several investments, such as stocks or bonds, at once. With a mutual fund, your investment is pooled with money from many other investors and a professional chooses the specific investments. There are generally three types:

• Managed funds typically pursue a stated strategy, such as only investing in a specific category of stock, only in municipal bonds, etc. What’s included in the fund determines how risky it is – and the higher the risk, the higher the return. Because the fund manager needs to be paid, managed funds usually have the highest cost of the three types, as measured by the percent of your investment that goes to pay the fund’s expenses.
• Index funds invest based on a specific stock index, such as the S&P 500. They buy shares in the companies included in the index so that the fund performance matches the index. You’ll sometimes hear this called “passive investing.”
• Exchange-traded funds (ETFs) similarly follow a benchmark index with the goal of matching that index’s performance but are traded on an exchange (like stocks). Index funds and ETFs are typically less expensive than standard mutual funds because there’s no fund manager to pay.

Peer-to-peer lending: Instead of buying shares or bonds, you lend money to individuals or businesses. Several online firms offer this option, which matches those seeking funds with those looking to invest in the debt. The investor makes money because the borrower pays interest on the loan. You may be able to get started with an investment as small as $25, but other peer-to-peer lending opportunities require an initial investment of $25,000 or more.¹ Note that this option does have some risk.

Investing for a long-term goal, such as retirement, gives many investors the breathing room to invest in riskier options that also may yield greater returns, because there’s more time to recover from losses. If you have a long-term goal and/or a higher tolerance for risk, you can certainly find stocks, bonds, and funds that are more vulnerable to losses but also offer potentially greater returns. But your options don’t stop there. There are other traditional – and non-traditional – types of investments. Among them:

Commodities are physical products you can buy and then hope to re-sell at a profit. Commonly traded commodities include precious metals, energy products such as oil or gas, and agricultural products such as corn. The risk is that factors beyond anyone’s control – such as the weather, in the case of farm products – can greatly impact the commodities market.

Real estate as an investment (distinct from your own home) has traditionally had a high barrier to entry. Depending on the market, appreciation – the value your investment gains over time – may be slow. And, as we saw in 2008, it may depreciate, making it an investment with some risk. It also typically requires a lot of cash to get started. That’s beginning to change thanks to real estate investment trusts (REITs). They mirror mutual funds in the sense that several pool their resources to buy property. Like stocks, you can buy them on an exchange.

Cryptocurrency is an emerging 21st century investment option – it’s digital currency such as bitcoin that’s not backed by any government. They’re traded on cryptocurrency exchanges. Because their value may fluctuate dramatically, they’re seen as a high-risk investment and many experts advise against them.

Once you’ve narrowed your focus to the short, intermediate, or long term and considered your tolerance for risk, here are some additional considerations before choosing specific investments:

• Educated investment advice can be invaluable. Look to independent professionals who get paid for their time rather than those who earn commissions.
• Embrace innovation because technology is changing the investment world. For example, robo-advisers use algorithms and sophisticated software to choose investments based on your goals and risk tolerance. Robo-advisers are generally less expensive than working with a financial adviser.
• If you make money, you may owe capital gains tax. Capital gains are the gain (or loss) you have on an investment, which is only taxed if you sell the investment and “realize” the gain. Unrealized gains are not taxed. If you buy and sell within a year, the gain is taxed as if it’s regular income; if held for more than a year, it is taxed at a lower capital gains rate.
• Experienced investors typically diversify where they put their money. To do that, start with simple options and gradually expand your portfolio.
• Read the fine print on any investment.