Main Asset Classes for Investment: Stocks, Bonds, Real Estate
In most cases, the best way to begin investing is to decide which asset classes you want to own: real estate, stocks, or fixed income. Each has unique risks, opportunities, and tax rules. While building a complete portfolio might seem difficult, the dividends, interest, and rents can be worth it.
You likely will gravitate toward specific asset classes based on your preferences, but it also is important to understand that different asset classes can meet different needs at certain times in your life. For example, when you’re younger and have more time ahead of you, the high growth potential of stocks makes more sense. If you’re 70 and retired, the more stable income from bonds is reasonable.
Almost all major assets you’re likely to consider when investing money fall under the categories of business ownership, lending money, or real estate.
Acquiring an Ownership Stake in a Business
Historically, ownership of a successful business has been a great source of wealth accumulation. Owning stock in a successful business can be accomplished in several different ways.
Buy stock in a publicly traded business. This is done by purchasing common stock in a corporation traded on one of the stock exchanges, such as the New York Stock Exchange (NYSE). You can invest through your brokerage accounts, 401(k) plan, IRA, direct stock purchase plans, or mutual fund accounts.
Start your own company. You can do this by establishing a sole proprietorship, general partnership, limited partnership, limited liability company, or corporation. If you have the talent, skill, discipline, and luck of an excellent operator, it is often the most lucrative path to investment riches because you can buy into the firm at book value with your compounding rate equal to the return on equity, or ROE.
Buy into someone else’s privately held company. Consider becoming a partner or otherwise buying into a private company, perhaps in exchange for cash or labor, on privately negotiated terms. Some investors specialize in private equity, restricting themselves to specific sectors of the economy where they feel like they have an advantage, such as technology or manufacturing.
Lending Your Savings
Money lending is as old as civilization. An investor saves up wealth and then lets others borrow it with the promise of repayment plus interest based on the risk and length of the loan. Issuing a loan, whether to a business, a person, or a bank, is a common way of investing money.
There are multiple ways to loan money:
Purchase bonds. Bonds are debt issued by sovereign governments—these include Treasury bonds or savings bonds—as well as municipalities, corporations, nonprofits, or other entities. They are easily purchased through a brokerage account.
Make a direct loan. This is a privately negotiated loan with a borrower based upon a written or verbal contract which details terms, conditions, a repayment schedule, and the interest rate.
Make a peer-to-peer loan. Lending through market platforms such as Lending Club or Prosper allows you to bid on a small percentage of a given loan and fund a piece of it.
Acquire a certificate of deposit (CD). When you buy a CD, the bank or other financial institution offers you interest in exchange for your deposit, which you agree to leave in place for a specified amount of time.
Just like investing money in a business, the compound annual growth rate you can earn when lending money depends on your skill.
Take one example: A retiree shrewdly acquires homes that she rents out on lease-to-own terms to families who otherwise couldn’t qualify for a mortgage. After adjusting for various factors such as taxes and maintenance, her cap rate is 13%. That’s a much better return than 2% interest for a CD or the 0.10% offered on savings bonds.
Nobody advertised such an investment; she created it on her own. She saw an opportunity and with a pen, a lawyer, a notary, and her savings, found a way to solve other peoples’ needs.
Investing Money in Real Estate
Behind lending money, making a profit from owning real estate is among the oldest recorded financial activities. If you own a property—whether a home, an office, or a plot of land—you can make money by charging rent.
In the modern economy, there are several ways to acquire real estate for your investments:
Buy a home for your family. This is more cost mitigation than it is an investment, but it falls into this category nonetheless.
Buy a property and rent it. When you own property, you can rent it to tenants.
Buy a property and sell it for profit. This is sometimes called “flipping,” which means improving or developing a property in some way and then selling it.
Fund lease/buyback transactions. In these situations, you buy a property and then lease it back to the seller.
Pool money to buy real estate through a trust. The most common technique with this method is to put money down with other investors to buy real estate through special tax-advantaged businesses exempt from corporate taxes (under most circumstances).