Eight easy ways to invest money

There is no best way to invest, but here are a few ways to invest money with explanations …

I ran across a question on Quora asking for the best investments for beginners.

Talk about an open-ended question, right? Even if I knew the person and knew what their goals were, it would still be an open-ended question.

But … I took a stab at it anyway.

Before considering ways to invest money …

A piece of advice I've heard for a long, long time:

Only invest in things you understand.

If you don't understand what you're going to invest in, then it's basically gambling. You might make some money — even a lot of money — but probably not.

Below I list a few types of ways to invest money and give a brief thumbnail description of how they work. I also include pros and cons of each type.

Eight straightforward ways to invest money

Cash

As in a bank or credit union account. Boring, right? Maybe, but it's awfully nice to have cash in lean or uncertain times. Companies are sitting pretty when they have a lot of cash. Very little speaks louder than cash and it makes it easy to buy other people's mistakes at a heavy discount. You may get a small amount of interest income from the money in your bank account. (Banks need money on deposit in order to lend it, because of reserve requirements.)

Because of inflation, the purchasing power of a dollar typically deteriorates, so it might be wise not to have everything in cash. It also has the distinction as being the most liquid asset. You can withdraw your cash pretty much whenever you want, and use it to purchase whatever you want. (Bonus: The Federal Deposit Insurance Corporation insures your money to $250,000 per bank.)

(Sometimes, occasionally, you could end up with dollar bills with fancy serial numbers, which is not only cool but could make your dollar worth way more than a dollar!)

Certificates of deposit (CDs)

CDs are like cash in the bank, and have much the same safety as cash, but they lock you in a bit more. Banks will bump up the interest rate they pay you if you agree that they can assess a penalty for withdrawing the money before a set period of time, like one year, three months, etc., because it reduces their deposit volatility risk. This allows them to plan more how they are going to invest.

The longer the time period of the CD, the higher the interest rate they pay, but also the longer your money is locked in.

Bonds

When you buy a bond, you are in effect lending money to who issued the bond. The issuer can be a municipality, the federal government, or a company, to name a few. Interest is paid either at the maturity date (where they give your money back plus interest) or periodically (where you get regular interest payments, called the coupon amount, and get your money back at the end). Depending on the type of bond, there is a greater or lesser risk of default. There's also a chance that it can be called back and paid out in full prior to the maturity date. The prices of bonds rise and fall with market forces (buying and selling). Like CDs, bonds lock in your money for (up to) the life of the bond, but the payments are comparatively reliable.

Stocks

A stock is partial ownership in one company. Stocks are traded in a market — a stock exchange. To buy a stock, you place an order for the stock, and a trader will go to the market to get the stock at the current price. You'll then get the stock in your account, and the money for the stock plus the commission (if any) will be deducted from your cash account. (Selling reverses the process.)

There are several ways to make money with stocks. The price of the stock could go up after buying it, and you could sell it later at a profit. The company might periodically declare dividends on the stock, which are payments to you, as the shareholder, if you own the stock at the appropriate time. You can even make money when the stock loses value by selling it short (borrowing the stock and selling it, creating an open position) and then buying it back at a lower price to close the position. (This is a more advanced strategy, and has a higher potential downside than ownership in the stock.)

Individual stocks are more volatile than cash; they can go up and down in value several percent or even double-digit percent in a single day.

(Note: If you get really serious into stocks then the performance of your trading platform becomes more important. This article talks about the features you'll want to consider in a trading laptop.)

Mutual funds

These are collections of a bunch of different stocks, bonds, currencies, cash, etc., sold as a single investment. They can be bought and sold through the market (exchange-traded funds, or ETFs) or through an investment company. The makeup of the individual things in the mutual fund is determined by the prospectus, and the fund manager will buy and sell to keep the distribution true to the prospectus. What this means is that you won't invest in a utilities fund and then come back six months later to find that you now have a whole bunch of high-risk bonds in the fund.

Having more types of investments in the fund spreads out the risk of any one thing failing. It diversifies your investment and decreases the volatility relative to any individual item in the fund. It's one of the commons ways to invest money that financial planners suggest.

Commodities

These are physical things like oil, gold, silver, copper, corn, wheat, pork bellies, etc. Their price is also determined by market. You can either take physical ownership of the commodity, or have a claim to the commodity stored elsewhere. Agricultural products like corn are bought (or sold) through a futures contract, which is an agreement to buy (or sell) the commodity at a set price on a set date. Unless you want that much corn, you would close out the position prior to taking delivery on it, and this would give you either a profit or loss on the trade. (Consider this: You might have some physical copper already. Copper cents minted prior to 1982 are 95% copper!)

Currency

This is simply investing in another country's cash. Many currencies float in value relative to the US dollar, like the Japanese yen, the British pound, and the Euro. If you buy Euros today for $1.10, and it strengthens to $1.20, you just made $0.10 per Euro (minus commissions) if you exchange it back for dollars. Like stocks and commodities, the exchange rate is market-driven. What causes currencies to go up or down relative to one another is different than what causes commodies to go up or down, and that's different than what causes stocks to go up or down. It pays to have a good reason for buying currency, also known as understanding your investments! (For my two cents, it's one of the riskier ways to invest money.)

Peer to peer lending

Peer to peer lending (or P2P lending) is a relatively new kind of security. Borrowers come to a peer-to-peer website like Lending Club or Prosper and request a loan for a particular amount. After the website collects and verifies the borrower's financial information, the website sets the interest rate for the pooled loan. (They used to let the market determine the rate but that didn't work out so well.) Then, lenders — other fellow peer human beings — chip in part of the loan, hopefully reaching the entire amount before the listing ends.

From there, the borrower makes payments to the website monthly, just as if they had gotten a loan from a bank. The payments are then distributed to the many lenders in proportion to how much they invested in the note (the securing document for the loan). If all goes well, the entire principal amount plus interest is repaid. If things don't go so well, then the note goes into default, and the borrowers get only a fraction of their investment back (if any).

The lenders can choose how much risk they want to take on. Just as banks charge more interest to people with low credit scores, P2P sites collect (and distribute) more interest from people with low credit scores, which means that investors get more money for riskier notes.

These eight ways to invest money are good places to start looking into, because again, I feel they're easy to understand.