New traders have a lot of different options for what types of investments they wish to buy and sell. It can seem overwhelming just knowing where to start! One way to begin your stock market training is to take some time understanding common investment types so you can research each of these in more detail.
Here are the Most Common Investment Types You Can Trade:
Stocks: Stocks are essentially a “piece of paper” which gives stockholders a percentage of ownership in companies. Stocks are created when a company offers shares to raise capital for operations. The company sells percentage ownership interests to their investors, which are known as shares. These shares are then purchased and sold through a stock exchange.
Mutual Funds: Mutual funds are a group of funds collected from many investors for the purpose of making an investment in securities such as stocks, bonds, and other assets. Mutual funds are controlled by financial managers, who invest the fund’s capital and attempt to bring forth capital gains and income for the fund’s investors.
Index Funds: Index funds are much like mutual funds, but instead of selecting a group of hand-picked stocks, an index fund is for an entire market or sector. Because they cover such a broad range of stocks, they are considered to be a passive investment which requires very little maintenance or observation.
ETFs: ETFs are exchange traded funds and are very similar to mutual and index funds. ETFs are an index which include a targeted market sector, for example, a group of stocks for the technology sector, or a group of stocks for the biotechnology sector. The biggest difference between ETFs and mutual and index funds is that ETFs can be traded like stocks, and their prices move up and down and change like stocks throughout the day. Many investors find ETFs in their portfolio can be a way to reduce risk by just choosing a specific industry rather than the performance of a specific company. Learn more about mutual funds vs. ETFs here.
Hedge Funds: Hedge funds are very similar to mutual funds. However, there are a few key difference. The U.S. Security and Exchange Commission (SEC) does not regulate hedge funds. Hedge funds are thought to be far more riskier than mutual funds because they can include a very wide range of assets and financial investments. Hedge funds often invest on money which is borrowed, which can further can increase risks and losses.
Commodities: Commodities are physical materials like oil, gold, or grain. The prices of commodities can affect stock prices, but they typically do not get traded the same way stock shares do. Commodities are usually invested in through a futures contract, which is an agreement to buy or sell a specific quantity of a commodity at a specific price at a set date in the future. See: Understanding Commodities Future Trading for an example of how these work.
Derivatives: Derivatives generally include futures and options, and they derive their value from other investments. Derivatives can be bought or sold in two ways. Some are traded over-the-counter (OTC) while others are traded on an exchange. This can be complex for someone new to the stock market, so it will take some time to fully understand how this type of investment can work for you.
Understanding these common types of investments will help you get started as new beginner investor in choosing what type of trader you want to become. You can choose whether to diversify your portfolio with a number of these different investment types, or you can choose to focus on just one trading strategy.
It is important to note that as a new trader you may feel the need to jump right in and try your hand at investing in derivatives, commodities, hedge funds, and stocks but as a new trader this is generally a really bad idea. It is best to do as much research as possible and consider starting out with low-risk investments at first such as mutual funds and the ETF’s. Also, remember that you can lessen your risk by investing in multiple ETFs and mutual funds that cover various industries. Remember that diversification is key when attempting to lower risk and as always make your own investment decisions and understand that you can lose everything when investing so be cautious.
Have any questions about the differences between these common investment types? Comments are always welcome below, or head over to the stock market forum to have your questions answered!