What Is an Investment Vehicle?
When you decide to invest money, you have a wide variety of assets that you can purchase.
Investment vehicles allow you to select groups of assets with the potential to gain value. However, some options carry more risk while others offer limited returns.
Certificates of deposit (CDs) tend to have a lower risk. Common high-risk investment vehicles include hedge funds, futures contracts, and high yield bonds.
Before putting your money in one of these investment vehicles, you should know more about the potential pros and cons.
What Is an Investment Vehicle?
An investment vehicle is a method that you use to invest your money. Cash, bonds, and stocks are the three main classes of assets that you can hold. The investment vehicle is simply the delivery method or product.
For example, your savings account is an investment vehicle for cash. Certificates of deposit, money market accounts, and treasury securities are also investment vehicles for cash and cash equivalents.
Exchange-traded funds (ETFs), index funds, and mutual funds are common investment vehicles for purchasing groups of stocks.
Choosing the Right Investment Vehicle
Each type of investment vehicle brings its own risks and potential returns. Many investors decide to hold several of these options.
Holding multiple types of investment creates diversification, spreading your money across different assets of varying risk levels. On average, diversified portfolios provide higher long-term returns.
Some of the main considerations for choosing an investment vehicle include:
- Market conditions
- Risk tolerance
- Financial goals
- Current finances
Market conditions should influence your investing strategy. During a recession, low-risk investments offer greater security. However, those with diversified portfolios tend to ride out economic hard times.
Risk tolerance refers to the amount of risk you feel comfortable with. Many beginner investors make the mistake of taking on too much risk, causing them to panic and sell their assets at the wrong time.
To assess your risk tolerance, consider how much money you feel comfortable losing during a bad year. You should also think about the time horizon for your investments. With more time, you may feel comfortable with greater risk.
Additional sources of funds also give the freedom to take on more risk. Social security, pensions, and existing real estate may provide stable funds in the future.
Analyze your financial goals and current finances before investing. Whether you choose short-term or long-term goals, it helps to set specific monetary milestones, such as a specific amount needed for retirement.
Low-Risk Investment Vehicles
After reviewing your risk tolerance and setting your goals, analyze your investment options. Start with the low-risk investment vehicles, as these assets tend to offer the greatest security.
Investments with the lowest risk include physical cash, money market accounts, savings accounts, CDs, and treasury securities.
Money market accounts and savings accounts offer the most financial stability. You can continue depositing funds in the accounts. However, the returns are very limited.
CDs also provide security. These investments are basically federally insured savings accounts. You can purchase a share certificate with a guaranteed return thanks to a fixed interest rate. CDs provide greater returns compared to a typical savings account, but have a fixed date of withdrawal.
Most types of bonds, except for junk bonds, provide low-risk investments. Bond funds and exchange-traded funds are two common options in the low-risk category.
A bond fund is a type of fund that primarily invests in bonds. They also have set time periods for maturity, offering short-term or long-term investing solutions.
Exchange-traded funds (ETFs) are another type of pooled fund investing. These funds pool securities together and may include hundreds to thousands of individual securities.
ETFs are funds that trade a collection of securities on an exchange. While the value of ETFs fluctuates throughout the day, they tend to offer limited risk.
Medium Risk Investment Vehicles
Medium or moderate risk investment vehicles tend to provide the best combination of risk and potential returns, especially for long-term investing.
Investing in stock mutual funds, precious metals, or real estate provides moderate risk. Some ETFs also include a mixture of securities to give you a better balance compared to low-risk ETFs.
With stocks, you purchase a share of ownership in a company. The value of the share fluctuates throughout the day of trading. These investment vehicles are more volatile for short-term investing. With stock mutual funds, you invest in a balanced set of stocks across the market, leveling the volatility of the fund.
High-Risk Investment Vehicles
High-risk investments mostly belong to the speculative investment category. Individual stocks, futures contracts, penny stocks, inverse funds, hedge funds, and the foreign exchange market (Forex), give you the greatest potential for high returns for short-term or long-term investing.
These investment vehicles also bring the most risk. Besides fluctuations in the value of the assets, you need to deal with the risk of getting out of an investment early.
Pooled Investment Vehicles
Pooled investment vehicles include any funds where investors pool their money. These options include mutual funds, hedge funds, ETFs, stock mutual funds, and real estate investment funds.
Professional fund managers or a group of financial managers select the assets included in the fund. Managers tailor funds to meet the needs of different types of investors.
You can find funds designed with low risk, moderate risk, or high risk. For example, hedge funds often include risky investments for achieving unusually high returns. For those not comfortable with the level of risk, many low to moderate risk mutual funds and ETFs exist.
Conclusion – Minimize Risk Through Diversification
Each investment vehicle brings its own pros and cons. Instead of putting all your money into one asset, minimize your risk through diversification.
Building a portfolio using multiple investment vehicles helps provide a balance between risk and reward. This diversification allows smart investors to weather economic storms and continue receiving positive returns.
Pooled investment vehicles also provide diversified solutions. With mutual funds or ETFs, you invest in hundreds or thousands of equities or financial securities without needing to pick and choose each one.
No matter which investment vehicle you choose, always review the risk and return rate to find an option that matches your comfort level and financial goals.