5 Types of Investments and How They Work

Lyle Daly
Natalie Taylor, CFP®, BFA™
5 Types of Investments and How They Work

Investing is a widely recommended financial habit, but since there are so many options, it can be challenging to know where to start. Getting into investing is much easier when you understand the types of investments so you can select the ones that fit with your goals.

In this guide, we’ll cover the most popular investment types, go over the different choices within each one, and help you build your portfolio.

What Are the Main Types of Investments?

The three main types of investments are stocks, bonds, and cash equivalents. Investments that aren’t part of these categories are considered alternative investments, such as real estate, precious metals, and cryptocurrency. There are also structured investment products, such as investment funds.

1. Stocks

A stock is an investment in a company. When you buy a stock, you’re buying an ownership stake in that company. Stocks are bought and sold in shares, and the more shares you own, the greater your ownership stake.

Stock prices fluctuate in value based on the success of the company and its current market outlook. You can build wealth through stock investing if the company’s stock price increases.

Stocks can also provide passive income in the form of dividends. Dividends are payments to a company’s shareholders from the profits it has made. Not all companies pay dividends, but many do.


  • High growth potential

  • Passive income potential through dividend payments

  • Thousands of companies to invest in


  • Volatile as stock prices can fluctuate quite a bit

  • Time-consuming to pick stocks

Types of Stocks

Some different types of stocks include value stocks, growth stocks, and dividend stocks. Here’s how these types of investments work:

  • Value stocks: Stocks that trade at a relatively low price compared to the company’s earnings and long-term growth potential.

  • Growth stocks: Stocks of companies that prioritize rapid growth and building revenue. These typically trade at a relatively high price compared to the company’s earnings.

  • Dividend stocks: Stocks that make a regular dividend payment to shareholders. While this can refer to any dividend-paying stock, it’s typically used for stocks that pay above-average dividends.

Pro Tip: Don’t start investing if you haven’t built up an emergency fund. Not sure how big yours needs to be? See our guide: How Much Emergency Fund Should I Have?

2. Bonds

A bond is a financial instrument that acts as a loan between the bond issuer and the investor. The bond issuer sells bonds as a way to borrow money. Each bond has a principal, which is the value of the bond, a fixed interest rate, and a term. The investor who buys the bond receives interest payments at set intervals. On the bond’s maturity date (the end of the term), the bond issuer repays the principal.

The federal government, municipalities, and corporations all issue bonds to raise money. Bonds are fixed-income investments because they provide stable returns. That’s a plus when you’re investing in a bear market. They’re considered low risk, although that depends on the type of bond.


  • Earn a stable fixed return

  • Generally low risk


  • More moderate returns than other types of investments

Types of Bonds

While there are many different types of bonds, the most common include:

  • Treasuries: These are bonds issued by the U.S. Treasury. There’s a range of choices here, including I-bonds that are tied to the rate of inflation (learn more with a full guide to I-bonds explained) and treasury bonds that are sold at auction. Since these are backed by the U.S. government, they’re as secure as it gets.

  • Municipal: These bonds are issued by state, county, and city governments. Called “munis” for short, they’re often used to fund projects, such as schools and highways. U.S. municipal bonds are also very safe investments.

  • Corporate: These are bonds issued by companies. Corporate bonds tend to offer higher interest rates, but the risk is also higher since they’re backed by corporations that can go bankrupt. You can check bond ratings to see the level of risk with corporate bonds.

Interest rates can improve your bond investment returns, but they can affect your finances in several other ways. See our article: Rising Interest Rates: How They Impact Your Finances

3. Cash Equivalents

Cash equivalents refer to financial instruments with high liquidity, meaning they’re easy to convert to cash. For example, money in a high-yield savings account is a cash equivalent, because you could turn it into cash at any time.


  • Little to no risk

  • Can quickly convert to cash

  • The cash equivalents below are all FDIC insured, which is a much more secure level of low risk than anything else.


  • Lower returns than most other types of investments

Types of Cash Equivalents

A few of the more common types of cash equivalents are:

  • High-yield savings accounts: Savings accounts that offer a high interest rate. These function like any other savings account, so they’re a secure place to store cash and earn interest on it.

  • Certificates of deposit (CDs): Deposit accounts that offer a fixed interest rate and term, with most ranging from six months to five years. You need to wait until the end of the CD’s term to access your money without penalty.

  • Money market accounts: Bank accounts that have higher interest rates like savings accounts and let you access funds with a debit card, checks, or both, like checking accounts. Money market accounts normally have higher deposit requirements than checking and savings accounts.

Pro Tip: During times of high inflation, a high-yield savings account is a good place to put your cash and earn more, but there are others. See our guide: Where to Park Cash.

4. Investment Funds

An investment fund pools money from a group of investors and invests it in various securities, such as stocks or bonds. This is one of the most convenient ways to invest. Because the fund invests your money for you, you don’t need to spend any time picking stocks. And since investment funds contain a large number of securities, you can get a diversified portfolio in a single investment.

Investment fund portfolios can be managed either passively or actively. With actively-managed investment funds, a fund manager selects and adjusts the investments. Passively-managed investment funds typically follow a market index, such as the S&P 500, and have much lower fees.


  • Diversifies your portfolio

  • Wide range of fund options

  • Saves time vs more hands-on types of investments


  • Fees, although these can be small with passively-managed funds

Types of Investment Funds

Some of the most popular types of investment funds are:

  • Exchange-traded funds (ETFs): Investment funds that are traded in shares like stocks, with prices fluctuating throughout the trading day. Most ETFs are passively managed, making them a good low-fee option.

  • Mutual funds: Investment funds that are sold by a brokerage firm or bank with prices set once per day. Most mutual funds are actively managed, but some types of mutual funds are passively managed.

  • Target date funds: Investment funds that are managed based on a specific retirement year, with asset allocation optimized for that retirement timeline. For example, a 2060 target date fund will be managed to get the best results for investors who want to retire in 2060.

Pro Tip: You can start investing even if you have some debt to pay off first — contrary to popular belief! See our guide: Should I Pay Off Debt Or Put Money In Savings?

5. Alternative Investments

Alternative investments are all asset classes outside of the three traditional types of investment vehicles: Stocks, bonds, and cash. These include a wide range of assets, with risk and return varying for each one.


  • Adds new assets to your portfolio

  • Wide range of options


  • Some alternative investments can be risky

Types of Alternative Investments

While there are many kinds of alternative investments, some common options are:

  • Real estate: Property that produces income either by renting it out or selling it for a profit. One of the most popular types is real estate investment trusts (REITs). These are companies that own income-producing property and are traded in shares like stocks.

  • Commodities: Materials and goods that fluctuate in value. There are hard and soft commodities. Natural resources, such as oil, natural gas, and precious metals, are considered hard commodities. Agricultural products, such as wheat and sugar, are soft commodities.

  • Collectibles: Any item valued by collectors. Examples include art, coins, antiques, and wine.

  • Cryptocurrencies: Digital assets that are stored online on a blockchain. Bitcoin is the most well-known, but there are thousands of cryptocurrencies. These are extremely volatile, making them a high-risk, high-reward investment.

Pro Tip: Budgeting can help you invest by spotlighting exactly how much money you have available for investing. See our guide: Why Is Budgeting Important to Your Family?

How to Choose the Best Types of Investments

To choose the best types of investments, first consider your goals and timeline. There’s no one-size-fits-all investment that’s great for every investor. Both your goals and the amount of time you have determine the most appropriate investments.

For long-term goals that you have five years or more to accomplish, stocks and stock investment funds are excellent choices. While these can be volatile from year to year, the stock market has historically done well over long time periods.

For short-term goals, it’s better to stick with more stable investments. Bonds, cash equivalents, and bond investment funds are all fairly safe options that can provide solid returns. (Corporate bonds and bond funds are not FDIC insured, while some cash equivalents are. Also, Fed bonds are just as good as FDIC insured since they're U.S.-government backed)

Your risk tolerance is another important factor when choosing investments. Most investors build a portfolio with multiple types of investments, with the exact makeup depending on their risk tolerance. If you want to reduce risk, you may opt for more bonds than stocks. If you’re comfortable with more risk, you could go for a stock-heavy portfolio and potentially add some alternative investments.

Pro Tip: While risk aversion is generally accepted as a reason to rein in your long-term portfolio, you shouldn’t use risk tolerance to balance a short-term portfolio to be more stock-heavy unless you’re an experienced investor. If you need the money within two years, you really shouldn't invest in stocks unless you can afford to lose a large percentage.

Building a Winning Portfolio

Now that you know about the major types of investments, you can pick the ones that fit your needs. It’s also important to stay on top of how your portfolio’s doing. Monarch Money makes it easy to monitor your investments and their performance.

Lyle Daly Personal Finance Writer
Natalie Taylor, CFP®, BFA™ Head of Financial Advice at Monarch

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