As you start to invest, you’ll learn there’s more to investing than stocks and bonds. In fact, there are quite a few different investment vehicles to choose from. Knowing what they are and how they work is important to being an informed investor.
The term investment vehicle describes a financial asset or account used for the purpose of investing or building wealth. Two of the best-known investment vehicles are stocks and bonds, but they’re just the tip of the iceberg when it comes to the different investment vehicles that are available.
Types of Investment Vehicles
Below are the most common types of investment vehicles.
1. Savings Account
Although it’s not commonly looked upon as one, a traditional savings account is one of the most commonly used investment vehicles in the world. Although savings accounts don’t offer very high interest rates, they do build your money over time.
An investment in a savings account is similar to making an investment in currency. When saving money in the United States, you’re effectively investing in and holding the U.S. dollar (USD). If the USD gains in value, your return on your investment is increased buying power. If the USD loses value, you lose money in terms of buying power.
Although savings accounts are some of the most commonly used investment vehicles, they’re also one that leads to diminishing returns. The strength in the U.S. currency and the ultra-low interest rates involved in savings accounts rarely outpace the rate at which the USD loses value due to inflation.
Nonetheless, most consumers are willing to take inflation-related losses over time for the peace of mind in knowing they have a safety net built into their savings accounts. This common investment vehicle is more about holding value than about generating big gains.
Pro tip: Online banks tend to have some of the best interest rates for savings accounts. One of our favorites is the CIT Bank Savings Builder account.
2. Money Market Account
Money market accounts are common investment vehicles similar to savings accounts. These accounts are opened in and managed by banks, and they pay interest. Unlike savings accounts, the money you invest in a money market account is used by the bank for its own investments in financial markets.
While these funds are being used for the bank’s investing purposes, you neither reap the rewards nor take the risks of these investments.
Instead, the bank simply pays you a larger interest rate on these accounts than what you see with traditional savings accounts in exchange for the permission to use your money in financial market transactions. The balance of your account remains available for you to withdraw when you need to, just as with a savings account.
Sadly, like savings accounts, money market accounts are highly inefficient for growing wealth when you consider the relatively low rate of return compared to inflation.
If you’re like most people, when you hear the term “investment vehicle,” the first thing that comes to mind is stocks. Stocks are the first investment vehicle on this list that are likely to outpace inflation and provide cumulative gains.
Stocks are financial instruments that represent shares of ownership in a publicly traded company. For example, if you own 10 shares of Amazon stock, you actually own a small piece of Amazon. As such, with your 10 shares, you’re entitled to profit as Amazon grows and generates more profits.
On the other hand, if Amazon’s popularity suddenly falls and the value of the company follows suit, your shares may lose value.
Shares of stock in a company also grant the shareholder voting power. Major financial transactions or other significant moves by the company’s management often require votes by shareholders, in which case your vote actually contributes to the way the company is run.
Moreover, some stocks pay dividends, which are a portion of the profits created over a period of time that are paid out to shareholders. Dividends offer an additional opportunity to realize gains from your investments outside of the standard growth in value seen in your shares.
Pro tip: Earn a $30 bonus when you open and fund a new trading account from M1 Finance. With M1 Finance, you can customize your portfolio with stocks and ETFs, plus you can invest in fractional shares.
Bonds are another commonly known investment vehicle. While they’re known for smaller returns than stocks, they’re also considered to be safer investments. Moreover, returns on bonds often outpace inflation-related risks.
In the simplest of terms, a bond is a loan — the investor gives this loan to a publicly traded company or government municipality. Bonds are generally issued with a face value of $1,000. That means investors pay $1,000 to purchase newly issued bonds.
When purchased, bonds come with a maturity date and coupon rate. The maturity date represents the date on which the bond becomes liquid and the borrower pays back the debt in full. The coupon rate acts as an interest rate and represents the return on investment the investor can expect to realize.
Although bonds are meant to be purchased and held until their maturity date, investors don’t necessarily have to wait the entire term of the bond to get their money back.
Bonds can be sold to other interested investors before maturity, but doing so often requires offering a discount, which means giving up a small portion of your principal investment.
5. Mutual Funds
A mutual fund is an investment vehicle that requires the participation of multiple investors. Essentially, money managers who operate mutual funds sell shares in the fund to a pool of investors.
These investment dollars are then used to invest in stocks, bonds, money market instruments, and other investment vehicles on behalf of the participants in the pool.
Throughout the entire process, the money manager handles the allocation of funds. This gives individual investors with relatively a small amount of investing capital the ability to have their money professionally managed in a portfolio of equities, bonds, and other securities.
As all shareholders combine their funds to purchase these financial instruments, all shareholders involved in the mutual fund participate proportionally in the gains or losses that are experienced.
Exchange-traded funds (ETFs) work just like mutual funds. A large pool of investor dollars are put together to purchase assets with the goal of creating gains. Also, as with mutual funds, participants proportionally share in gains and losses generated by the ETF.
The key difference between an ETF and a mutual fund is that shares of ETFs are publicly traded on the open market. That means they can be found on stock exchanges like the New York Stock Exchange and can be bought and sold just like an individual stock.
Because of the exchange-traded factor involved in ETFs, the value of a share in an ETF rises and falls not only based on the movement of underlying assets, but also as a result of demand for the fund itself.
ETFs are commonly based on an index. For example, owning a share in an S&P 500 ETF essentially means you own a share in a fund that owns every company in the S&P 500 index and works to mimic the returns realized by the index.
Although most ETFs are index-based, there are ETFs centered around industries, unique strategies, and more.
7. Precious Metals
Precious metals are safe-haven investment vehicles. That means when economic or market conditions are concerning, investors look to precious metals as a way to protect their investments from losses.
As a result of the increased demand for precious metals in the midst of tough economic and market conditions, the values of these metals tend to rise during these times. So, not only does this investment vehicle protect you in times of uncertainty, it can lead to a positive return while markets overall experience losses.
Pro tip: If you’re planning to invest in gold, you can purchase real gold bars through Vaulted. Either take delivery yourself or have them stored at the Royal Canadian Mint.
Derivative investment vehicles, for all intents and purposes, essentially don’t have any inherent value at all. They are nothing more than a proverbial piece of paper on which a promise is made or a bet is placed based on an underlying asset.
One of the most common forms of derivative investment vehicles is known as options contracts. With these investments, a broker sells a contract promising to buy or sell a stock at a price (called a strike price) that is either higher or lower than the current price.
The contract comes with an expiration date. At expiration, the contract seller must buy or sell shares according to the options contract if the strike price is reached.
For example, let’s say that ABC stock is trading at $100 per share. An options contract seller sells a contract agreeing to sell 100 shares with a strike price of $105 and a one-month expiration date. A buyer who believes ABC stock will rise more than that can buy the contract. The cost of each contract in this example is $5.
If two weeks later ABC stock is trading at $110 per share, the options contract buyer can decide to strike. The buyer purchases the 100 shares from the contract seller at the $105 strike price, even though they are worth $110 on the open market.
At the end of the transaction, the yield for the buyer is $500. After subtracting the $5 fee to purchase the contract, the buyer would have made $495 in this example.
If instead the underlying asset never reaches the strike price prior to expiration, the contract expires and the option buyer is left with a loss equal to the cost of the contract. In this example, the contract seller keeps the $5 fee and no shares trade hands.
The value of options contracts is derived from the value of the underlying asset, not the ownership of the underlying asset.
9. American Depositary Receipts
American Depository Receipts, or ADRs, are a lesser-known investment vehicle that gives Americans safe exposure to foreign stocks. ADRs are negotiable certificates that are issued by a United States depository bank.
Each ADR represents one or more shares of a foreign company’s stock. However, they trade on markets in the United States as any American stock would.
The benefits of ADRs work in two ways. First and foremost, they give investors an easy way to gain exposure to growth in foreign markets. Moreover, they offer foreign issuers the opportunity to benefit from American investment dollars.
10. Limited Partnership Interests
Limited Partnership Interests are investment vehicles that are most commonly taken advantage of by the sharks on Wall Street. A limited partnership interest represents a stake in a business entity that’s owned by one or more general partners and one or more limited partners.
While both general and limited partners share in the financial investments involved in getting a company going, limited partners are limited to financial assistance. They have no hands-on interest in the company other than providing funding.
The limited partnership interest represents the share of the company owned by the limited partner. While the average retail investor will never have a limited partnership interest, the companies that you invest in may. So it’s important to understand them because that could cut into your return on investment.
11. Shares of Beneficial Interest
Shares of beneficial interest are shares that give the shareholder the right to receive benefits associated with assets held by another party.
For example, in trusts, a beneficiary has a vested interest in the trust’s assets and receives income from the trust’s holdings, but the beneficiary doesn’t actually own the accounts.
In the stock market, shares of beneficial interest are often seen in the form of royalties and other contract-related payments.
For example, a biotechnology company develops a new drug for lung cancer. Unfortunately, that company cannot afford to commercialize the drug. Rather than closing shop and giving up, the company can sell the rights to commercialize the drug to a larger, more financially stable company, but retains shares of beneficial interest.
As such, when the new drug is sold, the company that developed the treatment receives royalty and milestone payments but does not actually own the right to sell the drug.
12. Tracking Stocks
Tracking stocks work a lot like traditional stocks. However, they only give the investor ownership shares in a portion of the company.
These stocks provide shares of interest in a subsidiary of a larger company. For example, Alphabet owns Google along with several other subsidiaries, including the biotech company Calico. At some point, Alphabet may decide that it wants to sell shares in Calico, but does not want to spin Calico off to form its own entity.
In this case, Alphabet would issue tracking stock shares of Calico. Those who purchased Calico tracking stock would hold an ownership stake in the Calico subsidiary, but not in the larger parent company, Alphabet.
13. Convertible Debentures
Convertible debentures are also known as convertible bonds. These are forms of long-term debt issued by publicly traded companies. Like bonds, convertible debentures are sold in predetermined amounts with fixed interest or coupon rates and maturity dates, although the rates tend to be lower than those of traditional bonds.
To make up the interest difference between convertible debentures and bonds, convertible debentures can be converted into shares of stock after a specific period of time. Most convertible debentures are unsecured bonds or loans, with no underlying collateral used as part of the debt.
The convertible nature of convertible debentures gives investors a sense of security in knowing that their investments can be converted into shares of the company, leading to a higher level of liquidity and the option for a faster exit should things start to go south.
14. Preferred Stocks
A preferred stock is a share of stock that comes with added benefits when compared to a “normal” share of common stock. When issuing preferred stocks, issuers set the additional benefits that lead to these shares being “preferred.”
Preferred shares can have a range of benefits over common stock, including but not limited to:
- Voting Rights. Preferred shareholders may get more say in a vote than common shareholders, making these types of shares preferred among shareholders hoping to influence the decisions made by the company’s management.
- Debt-Like. Preferred stock can be a hybrid investment vehicle. These shares always have properties of stocks, including benefiting from growth and shares representing ownership. However, unlike common stock, preferred stock may include properties commonly seen with debt, such as an interest rate, that increases gains.
- Higher Dividends. Preferred shareholders may be paid a larger dividend than common shareholders.
Rights, or rights issues, give existing shareholders the right to buy more shares at a discount to the current trading price at a future date. Rights are often included in fundraising transactions.
For example, company XYZ may need to raise $5 million. To do so, XYZ issues shares equal to $5.5 million, discounting the initial purchase to drive institutional interest.
However, these shares may be sold as units that include rights to purchase additional shares at or near the price of the offering. Once the maturity date of these rights comes to fruition, investors can exercise their right to purchase newly issued shares or decide not to.
This would mean a significant extra gain for rights holders if XYZ’s stock soars — they can buy more shares of the stock at or near the original offering price.
Rights and warrants are very similar. Both are commonly used to sweeten the pot in fundraising transactions, and both give the investor the right to purchase shares at a discounted price. The difference between the two is the time frame during which transactions can take place.
Whereas rights give investors the opportunity to purchase shares at a discounted price on or after a predetermined date, warrants give investors the opportunity to purchase shares at a discounted price up to a predetermined date.
If the investor fails to purchase the discounted shares by the expiration date on the warrant, they give up the right to purchase these shares.
Finally, units are a combination of multiple investment vehicles sold as a single unit. Units are often used in public offering transactions through which companies intend to raise funding for one of a multitude of reasons.
For example, XYZ company needs to raise $5 million. At the moment, XYZ is trading at $1.00 per share. To build interest and get the investing community to participate in the fundraiser, the company drops the price and will sell shares at $0.90.
Like on your favorite infomercial, that’s not all — the $0.90 price will be the price of a unit that includes one share of XYZ stock, one warrant to purchase another share of XYZ stock that expires in six months, and one right issue to purchase one more share of XYZ stock beginning 60 days from the date of purchase.
This bundle of all three financial instruments involved in the offering is known as the unit.
If you’ve decided it’s time to start investing, you’ve made a great choice. The earlier you decide to invest, the more time your money has to work for you and the better your chances of becoming proficient or even excelling at it.
Of course, before you start to invest, it’s important to know all of your options. Each investment vehicle above comes with its own risks and potential rewards.
Make sure to take the time to consider which investment vehicles fit in best with your strategy as you explore the world of investing. It may also be wise to consult with a financial planner or investment advisor to help you get started.