You make a money deposit to your bank with condition that the money cannot be withdrawn for a certain period of time. Depending on the chosen term, bank will offer you different interest rates. For example – you deposit $1000 for 1 year, and get 1% interest. After the year has passed, you will have earned 1% of $1000 or $10.
$10 return is not much, but that is what you get for a very safe investment – you know exactly how much you will get back before investing and unless your bank or government fails, your money should be safe. But before you do any time deposits, consider also the drawbacks:
1. Your money is frozen for the selected period of time and you cannot use it. In case you decide to withdraw it sooner, you will need to pay a penalty that will most likely be higher than the interest rate.
2. In most stable countries inflation is higher than interest rates from time deposits, so if the interest rate is 1% and inflation is 2%, then after 1 year you will have gained $10 from investment and lost $20 to inflation. In short – you freeze your money, let bank make profit from it and get back less that you had.
When a country or large organization needs to borrow money, they cannot get a loan from a bank because the amount is too big. They issue bonds instead – this way anyone can loan them money.
Bonds are considered to be a safe and conservative investment – it is a good option when you cannot tolerate the short-term volatility of the stock market or when you are getting old and want your investments to be in the form of fixed-income.
Comparing to time deposits – bonds provide higher returns – on average 5-6% per year, but sometimes they can also have negative yield. You can consider also junk bonds to aim for better ROI – but note that junk bonds have higher risk of a default.
When buying stocks, you become a shareholder of a specific company, and over time – as the company and its value grows, your shares become more valuable. In the long run stocks provide around 10% return per year, but in the short term they can have high price volatility.
Depending on your strategy – you can get 20-100%+ returns by taking higher risks and investing in high-growth companies or recent IPOs.
Besides good returns another advantage is liquidity – if you need cash or see better opportunities where to invest it is easy and fast to sell your stocks at a fair price.
With higher rewards you get higher risks – if you have only one or few companies in your portfolio, then you could loose a significant part of your investment in case one of them fails. For example – check out the history of Blackberry stock prices. The solution is diversification – build your stock portfolio of 20-25+ companies.
Another thing to consider – check the fees that you will pay to your broker, bank or trading platform and make big enough trades so that fees would not make significant % of your trade value.
If you like the advantages of stocks, but don’t want to build a huge portfolio to deal with diversification, then ETFs is the perfect solution – you can buy equity traded funds just like stocks and get diversification like in actively managed funds, but with much lower management fees.
When you buy an ETF – you basically buy a specific group of stocks. ETF can track a broader range of stocks – it can attempt to mimic the returns of a specific index like Dow Jones, S&P, Nasdaq, or a specific sector (large caps, small caps, growth, value) or a country or region (Europe, BRIC). There also specialized ETFs that cover specific industries like technology, energy, etc.
So the main advantage is diversification and low fees, but what some might call a disadvantage – your returns equal the return of index that the ETF follows, and you won’t beat the market.
One of the most popular ETFs is QQQ – it follows NASDAQ-100 Index, which includes 100 of the largest domestic and international nonfinancial companies listed on the Nasdaq Stock Market based on market capitalization. And if we look at the performance – you can see good results for the past 5 years.
Actively managed funds
An exchange-traded fund follows some index and its goal is to match its performance, but an actively managed fund seeks to outperform a relevant index and beat the market.
The promise is that fund managers will do lot of research, find market inefficiencies, take advantage of them and provide higher returns for investors.
In reality – many actively managed funds are “closet indexers” – closely following some index, just with their higher fees added for investors. And even when a fund manager is doing a good job, the fees still might hinder of getting better returns in the long run.
Available only for investors with net worth over $1 million, hedge funds face little regulation and can be very flexible with their investment strategy – they can invest in almost anything – stocks, currencies, real estate, Bitcoins, etc. And to get higher leverage, hedge funds often borrow additional money as well.
In a typical case hedge fund will take 2% management fee and 20% cut of any gains. As fund management is expected to produce high returns, they often do risky and aggressive bids, and it is not unusual for a fund to go bust. Recent example: Canarsie Hedge Fund lost $59,8 million of their $60 million assets in 3 weeks.
If you have lot of money, feel like gambling and trust the strategy of any particular hedge fund, then go for it, but do your research beforehand and take into account that most hedge funds fail.
Trading currencies is like playing slots – even if you manage to win something in short-term, in the long run you are almost guaranteed to loose all your money. There are so many factors that influence currency prices, not even professionals can predict the changes.
Another problem is many scams around Forex, but even if you don’t fall for them, most likely the only one who will make any money – is the broker or platform you use for trading.
So stay away or be ready to loose your money faster than these guys get naked and wet.
Bitcoin is the most popular one, but there are hundreds of others – and based on the open source code anyone can create his own crypto-currency. You just need some coding skills and convince others to buy and trade it.
If stocks seem like high-risk investment, then virtual currencies are the wild west – many countries don’t know how to regulate them, once in a while some of largest exchanges do some shady or stupid stuff and end up closing, and if you get hacked – there is no way of getting your coins back.
Even if you are very careful when selecting a trusted exchange and know how to store your Bitcoins securely, then you still need to deal with insane price volatility. Just look at the history of Bitcoin price:
|Feb 2011 – April 2011||$1|
|8 July 2011||$31|
|April 11, 2013||$266|
|November 2013||$350 – $1250|
The bottom line is – if you are not afraid of the risks and want to buy some crypto-coins, then get ready for your investment to either explode or fail. But don’t get too excited – this is not for gamblers!