Types of Investments
Creating a diversified portfolio takes all kinds of investments. By understanding what’s available, you can decide which ones work for you.
What is a mutual fund?
Mutual funds pool money from many investors to purchase a broad range of investments, such as stocks, bonds, cash, or other types of securities. They’re an efficient way to begin investing and building a portfolio.
How a mutual fund works
Mutual funds can be an efficient, cost-effective way to invest. When you make an investment in a fund, you purchase shares of the fund, which means you own a portion of all of the underlying investments. A mutual fund can help provide built-in diversification, professional management, and ongoing supervision of the fund’s holdings—all important elements of a well-rounded investment program.
The potential advantages of mutual funds
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Built-in diversification
You’re often invested in several companies within an industry, or even a broader mix across industries, without having to do the work of choosing individual stocks or bonds.
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Professional management
You can leave the day-to-day decision making that may arise from changing market conditions to the expertise of professional portfolio managers.
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Convenience and daily liquidity
For a modest amount, you’re able to invest in a diversified portfolio for much less than you might pay for individual securities. You can also buy and sell mutual fund shares quite easily.
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No-transaction-fee options
Thousands of funds are available at Schwab without loads or transaction fees. (There are underlying costs to managing a fund, factored into its total return.)
The potential risks of mutual funds
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About risk
Mutual funds are subject to the fluctuations of the market, depending on what types of investments they hold. They are not FDIC-insured and do involve some investment risks, including possible loss of principal as well as fluctuation in value.
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How risky is it?
A fund’s investment objective, the investment approach of the fund manager, and the fund’s underlying holdings are influential factors in determining a fund’s risk.
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Before you invest
Carefully consider whether the fund’s investment strategy and its potential risks are a good fit for your risk tolerance.
| Type | How it works | May be a good option for |
|---|---|---|
| Mutual fund strategies | ||
| Index fund | Attempts to mimic the performance of a specific market index, such as the S&P 500® Index or the Wilshire 5000 Index. | First-time and seasoned investors who want broad market exposure and lower fees than those offered by actively managed funds. |
| Actively managed fund | Professional managers choose what they believe are the best investment opportunities, given a fund’s strategy, with the goal of outperforming a specific benchmark. | Those who want a professional manager’s investing experience and skills. |
| Mutual fund offerings | ||
| Stock (or equity) fund | Invests in U.S. and/or international stocks. These funds offer the potential for long-term growth and have varying risk levels. | First-time and seasoned investors who have a longer-term horizon. |
| Bond fund | Invests in either taxable or tax-free corporate, municipal, or government bonds. | Those looking for income or those who want a more conservative alternative to equity funds. |
| Blended or balanced fund | Invests in a mix of stocks and bonds with the goal of achieving both investment growth and income. | First-time and seasoned investors seeking a more diversified solution. |
| Target-date or life-cycle fund | May hold a mix of stocks and bonds, and automatically shifts its asset allocation as the date you need the money (when you retire, for example) draws near. The funds are built for investors who expect to start gradual withdrawals of fund assets on the target date, to begin covering expenses in retirement. The principal value of the funds is not guaranteed at any time. | Retirement investing and automatic rebalancing. |
- The companies are headquartered in the United States.
- The stocks are actively traded on the American Stock Exchange.
- The stocks have pricing information that is widely available to the public.
What is an ETF?
An ETF, or exchange-traded fund, is a single investment that generally holds a basket of securities (such as stocks, bonds) and trades like a stock. It can offer built-in diversification similar to an index mutual fund, but it differs in that you can buy or sell shares anytime throughout the trading day.
How an ETF works
When you own an index ETF, you own a single investment representing a basket of chosen securities (such as stocks and bonds) that typically tracks to an index. The value of the ETF fluctuates with the value of the underlying index. In that sense, an index ETF is similar to an index mutual fund, but there are some differences.
The potential advantages of ETFs
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Costs can be lower
ETFs generally have low management fees compared with actively managed mutual funds. Fees are often even lower than those of index mutual funds.
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Diversification
ETFs can help you diversify by giving your portfolio exposure to a particular segment of the market.
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Easy to trade
You can buy or sell shares anytime during the trading day, as with stocks. (You will typically pay a commission for each purchase or sale, unless you are trading commission-free ETFs.)
The potential risks of ETFs
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About risk
Every type of investment involves risk—meaning there’s a chance you could lose money (both principal and any earnings).
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How risky is it?
Some risks can be reduced by ETFs’ ability to diversify across a wide range of securities and asset classes.
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Before you invest
Like many investments, ETFs are not FDIC-insured. If the index that your ETF tracks experiences a downturn and you to decide to sell, you will likely lose money.
What is a stock?
A stock is an ownership share in a corporation. As a company’s earnings improve, investors generally become more willing to buy the stock. Ultimately, stock investors hope to achieve gains in the form of dividends paid to stockholders (although not all stocks pay dividends) and in the form of capital gains.
Building and managing a portfolio of individual stocks takes a lot of time, effort, and money—which is why many investors find mutual funds or ETFs to be a more time-efficient and cost-effective solution.
How a stock works
When you buy a share of stock, you’re entitled to a small fraction of the assets (and dividends, if the company’s management chooses to pay them) of that company. The value of the stock is set by many people trading it in a free, open market—most often a stock exchange. The price of a stock fluctuates according to supply and demand, with many factors influencing these two broad aspects of stock prices.
The potential advantages of stocks
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Do it yourself
Stocks can be a good option for investors who have time to evaluate and analyze individual stocks and who have the money to achieve an appropriate level of diversification.
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Greater return potential
If you do your research and pick the right companies to invest in, you can potentially succeed as they succeed.
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Accessibility
Because so many companies sell stock, the stock market is a very accessible way to invest. You can generally buy or sell shares anytime during the trading day (note: you pay a commission on each purchase and each sale).
The potential risks of stocks
See potential advantages of stocks-
About risk
Every type of investment involves risk—meaning there’s a chance you could lose all or a portion of your investment.
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How risky is it?
Even with a carefully thought-out strategy and a well-diversified portfolio, investing in individual stocks can be very risky, as you are investing in an individual company.
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Before you invest
Carefully consider your investment objectives and your tolerance for risk in deciding whether investing in individual stocks is a suitable approach for you.
| Size of stock | Description |
|---|---|
| Large-cap | The largest 14% of domestic companies in terms of market value |
| Mid-cap | The next largest 42% of domestic companies in terms of capitalization |
| Small-cap | The remaining 44% of companies in terms of capitalization |
| International | Foreign (non-U.S.) companies |
| Global | Foreign and domestic-based companies |
| Origin of stock | Description |
| International | Foreign (non-U.S.) companies |
| Domestic | Companies based within the U.S. |
| Characteristics of stocks | Description |
| Style | Refers to whether a stock is a growth or a value (underpriced) investment |
| Sector and industry | Stocks are usually divided into
10 sectors:
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What is a bond?
Cities, states, the federal government, and corporations issue bonds to raise capital for purposes such as building roads, improving schools, opening new factories, and buying the latest technology. When you invest in a bond, you become one of the bond issuer’s lenders. In fact, a bond is like an IOU—a promise from the borrower to pay back the money you’ve loaned, with interest.
How a bond works
The potential advantages of bonds
See potential risks of bonds-
Individual bonds can help provide stability for your portfolio. By diversifying your investments across different asset classes—such as stocks, bonds, and cash—you can balance your risk versus potential return. Investors also use fixed income for savings and to generate income.
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Predictable income
Most bonds provide a regular stream of interest payments on specified dates. As a result, bonds can be used to try to generate a predictable stream of income to supplement an existing income or create one in retirement.
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Preservation of principal
Most bonds have a stated maturity date when principal is expected to be returned. As a result, certain types of bonds can be used to try to protect principal and can be useful when you’re saving for future expenses such as buying a home or paying for college tuition.
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Diversification
Adding bonds to a stock portfolio can help lower the portfolio’s volatility over time because stock and bond prices historically have not generally moved in the same direction and in the same magnitude at the same time.
The potential risks of bonds
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While many people consider bonds to be less volatile than stocks, bonds do have some unique risks of their own. Before you invest, carefully consider whether the investment strategy and risks of the bond are a good fit for you.
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Interest-rate risk
Bond prices tend to move in the opposite direction from interest rates. When interest rates rise, the prices for bonds tend to fall; when rates fall, prices tend to rise, all else being equal.
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Inflation risk
Over time, inflation can severely erode the purchasing power of interest payments and principal.
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Liquidity risk
Investors may encounter liquidity risk when they sell a bond before maturity and incur high transaction costs, or a significant reduction in price compared to buying the same bond at the same time.
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Credit risk
A bond issuer may be unable to make interest payments or return principal at maturity due to default.
| Type of bond | Issued by | May be a good option for |
|---|---|---|
| Treasuries (bonds, notes, and bills) |
Treasuries are issued by the U.S. government to pay for operations and fund the national debt. | Investors who are looking to preserve principal and are willing to give up some potential yield for a higher credit quality investment. |
| Municipals or “munis” | Municipal bonds are issued by state and local governments (and businesses owned by public authorities) to fund public projects. | Investors in higher tax brackets or those looking to reduce taxable income. |
| Corporates | Corporate bonds are issued by companies to fund operations or expansion. | Investors who want to increase potential income and are comfortable with some potential credit risk. |
| Treasury Inflation-Protected Securities (TIPS) | TIPS are issued by the U.S. Treasury and pay a return based on the rate of inflation. | Investors who are looking to preserve principal and want to protect that principal from the effects of inflation. |
| Agencies | Agency bonds are issued by either a government-sponsored enterprise (GSE) or a government-owned corporation. | Investors who are looking to preserve principal and want liquidity and tax advantages along with the potential to earn a higher yield than that of Treasuries. |
| Mortgage-backed securities (MBS) | MBS are issued by either a GSE or private mortgage lender. | Investors who are comfortable with the risks and complexities of the products and are looking for regular income, as MBS pay both interest and a portion of principal on a monthly basis. |
Top Questions
Key differences between fixed income and stocks |
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| Stocks | Bonds | |
| Investment Objectives | Growth and to outpace inflation | Stability, diversification, and income |
| Risk | Higher. Principal values can be volatile. In the case of bankruptcy liquidation, stockholders receive their payment after bondholders and other creditors. | Lower. Mainly includes interest rate, credit, and liquidity risks. |
| Income | May or may not pay quarterly and special dividends | Most pay a stated amount of interest to holders each year, typically semi-annually, sometimes monthly or quarterly. |
| Maturity | Have no maturity date | Most have a stated maturity date when principal is expected to be returned. |
| Ownership | Ownership in the company; stockholders have voting rights | No ownership; bondholders are considered creditors of the issuer and do not have voting rights. |
| Trading | Trade through a centralized exchange, which consists of competing buyers and sellers | Most bonds trade over the counter (OTC) or between bond dealers away from a central exchange. |
What are cash investments?
Options for investing your cash include certificates of deposit (CDs) and money market funds. With CDs, you choose a specific amount of time to invest your money, and at the end of that time period you receive your money back along with interest. Money market funds are mutual funds that hold a portfolio of high-quality, short-term investments. They pay a variable yield based on the performance of those investments.
How cash investments work
Cash investments provide a return in the form of interest payments. They are typically lower risk than other investment options, such as individual stocks or stock funds, but also typically offer a lower return.
What to consider before choosing a cash investment
Before choosing a cash investment, consider why you are holding the cash and how you plan to use it. Depending on what you plan to do with your cash, you may have specific preferences for liquidity, a fixed versus variable yield, and FDIC insurance.
| Type of cash investment | How it works | A good option for | |||
|---|---|---|---|---|---|
| Liquidity | Fixed or variable yield? | FDIC-insured? | |||
| Certificates of deposit (CDs) | When investing in a CD, you deposit a fixed sum of money for a specific amount of time, after which you get back your principal plus interest. Schwab offers a marketplace of CDs through Schwab CD OneSource®, allowing you to buy CDs from banks across the country through the convenience of one brokerage account. | Investors who value FDIC insurance, principal protection, and a fixed rate of return and do not mind locking their cash up for a specific term2 | Based on term | Fixed annual percentage yield (APY) | Yes2 |
| Money market funds | Money market funds are mutual funds that hold a portfolio of high-quality, short-term investments. Shares must be actively bought or sold just like other mutual funds. | Investors who are seeking a competitive yield and next-business-day liquidity and who do not prioritize FDIC insurance | Generally available on the next business day | Variable (based on portfolio yield) | No |
2. Funds deposited at an FDIC-insured institution are insured, in aggregate, up to $250,000 per depositor, per insured institution based upon account type, by the Federal Deposit Insurance Corporation (FDIC). The FDIC considers any other deposits you may have with an issuing bank. CDs you purchase from a particular bank are aggregated with any other deposits you may have with the issuing bank for determining FDIC insurance coverage (e.g., if you already have deposits of $250,000 with a bank, do not purchase CDs from the same bank in the same ownership category). Because the deposit insurance rules are complex, you may want to use the FDIC’s Electronic Deposit Insurance Estimator (EDIE) to estimate your total coverage at any particular bank.