Investments come in an enormous array of shapes, styles, values and properties. Individual investment tools can be categorized or classified using any number of criteria.
The same investment may be classified differently by different investors or over time by the same investor, depending on which criteria are being used as the filter at any given point.
Taken as a whole, the multitude of different categories and classifications can sometimes feel overwhelming to new investors. Fortunately, a few simple and standard divisions can help investors quickly sort diverse investment options into manageable chunks.
Vehicles provide a simple analogy of this. If a buyer looks at all of the vehicles it is possible to buy, then he or she will immediately be inundated by body styles and brands. By focusing on a few key characteristics (e.g. size or gas mileage) that are important to him or her, the buyer can instantly reduce their choices to a more reasonable level. If a buyer decides to look for a vehicle with four-wheel drive, then he or she might find vehicles as different from another as compact cars and large SUVs in the same category. If the buyer changes the criteria and looks instead only at vehicles with good gas mileage, then the compact car will remain but new vehicles will replace the SUV. Sorting and selecting investment tools works the same way.
It is important for investors to be aware that not all opportunities presented as investments are actually viable financial tools. Many marketers misuse the term “investment” in an attempt to portray their products or services in a better light. Looking out for these marketing traps can help investors protect their finances and ensure they get the best possible return on their investments.
First order classification of investments involves sorting opportunities into three categories. Ownership investments involve purchasing an item or a share of a company that the investor has good cause to believe will increase in value over time, thus returning a profit. Lending investments are arrangements in which investors provide money to a company or government agency in return for eventual repayment with interest, much the same way a bank would offer a loan to a customer. Cash equivalent investments are financial tools that are immediately and easily reversible to cash or which may be treated like cash in other key ways.
Most investors are familiar with the idea of ownership investments, even if they do not think of them in those terms. Stocks and commodities, for example, are common forms of ownership investment. Buying and holding precious metals, such as gold and silver, is also a type of ownership investment. Although often overlooked, fine art and collectibles can qualify as investments of this type as well if investors purchase and maintain them with the intention of reselling them for a profit.
Less common forms of ownership investments include entrepreneurship (launching and building a successful business) and real estate. An investor’s home does not qualify as an investment because its primary purpose is to be lived in. Properties purchased with the intent to resell them at a profit, regardless of whether the investor improves them or not prior to resale, are a legitimate form of investment.
The most prevalent form of lending investments is bonds. There are many forms of bonds, but all qualify equally as valid Lending Investments. Some investment professionals also consider savings accounts a form of lending investment in which banks serve as an intermediary. This is because banks use the money that individuals store in their savings accounts to make loans to other individuals and businesses. Often, they pay small amounts of interest to the account holder, as well. In that respect, savings accounts qualify as a very low risk and low return lending investment.
Money market funds are the primary form of cash equivalent investments. Money market funds are low-risk mutual funds with a target share price of $1 each. Money market funds specialize in stocks, bonds and other tools that are safe and very short-term. They are intentionally easy to buy into and cash out of and do not carry the fees and charges generally associated with other mutual funds.
Marketers often attempt to sell a variety of other products, services and experiences as “investments.” Standard examples include educational courses, electronics, office equipment or tools and health aids. Although these things may subjectively improve an investor’s quality of life, they cannot reasonably be purchased with the expectation that they can be resold for a profit. Nor will any third party pay the investor regular interest payments for having purchased and holding on to any of those items. Understanding this distinction can protect investors and help them direct their funds into true investments positioned to help them achieve their financial goals.
Once investors have familiarized themselves with the primary types of investments, they can explore the secondary characteristics that the market uses to divide and describe investment tools.
Traditionally, investments have been classified almost exclusively based on financial characteristics and performance. However, many modern investors have begun to seek out investment opportunities using other measures of quality and performance. One of the most visible examples of this has been the rise of Socially Responsible Investment initiatives (SRI).
SRIs intentionally seek out companies for investment that meet particular social-based criteria. For example, investors may look for companies that engage in or support clean energy, environmental sustainability or social justice. Alternatively, they may actively seek to avoid investing in companies that produce addictive products, such as alcohol or cigarettes, or companies with reputations for social inequality or negative marketing practices. Mutual funds, exchange-traded funds and other investment companies have recognized this trend and are increasingly making easy, socially-conscious investment opportunities available.
Although SRI will not be of interest or importance to all investors, it can be important for investors to remember to consider all the aspects of investing that are important to them when doing their research and making investment decisions.