APMacro: Types of Investment

Investment-Pyramid_full

We invest money in everything from rare coins to real estate because we expect a favorable financial return in the future. However, not all investments turn out as we hope and expect. Nearly every kind of investment involves some sort of risk. For example, the price of rare coins or houses can go down as well as up. Generally, there is a strong relationship between risk and reward. The higher the potential reward an investment offers, the higher the risk of losses rather than gains. Therefore, in choosing what to invest in it is important to weigh the various risks against the potential rewards.

You don’t need to take great risks to ensure a safe return on your investments—if you are patient. You can invest your money conservatively and let the passage of time increase its value. The trick is to take advantage of the power of compounding. Compounding refers to the ability of an investment to generate earnings that can be reinvested to earn still more earnings. Banks make this happen when they pay depositors compound interest, rather than simple interest, on their savings. Compound interest is interest paid not only on the original amount deposited in the savings account, but also on all interest earned by those savings.

Suppose you left your savings in the bank to compound year after year. In time, you would double your investment. But how long would this take? To find out, you could use the rule of 72. This rule says to divide the number 72 by the annual rate of return on the investment. The answer is the number of years it will take to double the original investment.

We invest in a variety of financial assets, including savings accounts, government bonds, corporate bonds, stocks, and mutual funds. Each has its own level of risk and expected reward. You will learn about the five types  of investing risks and then compare the risks and rewards of several of the most frequently used types of investments.

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