The Essence of Investing
When you invest, you put your money to work with the goal of generating wealth over time. There are many different types of investments, with varying levels of risk, ⓘ expected returns, ⓘ and liquidity. ⓘ
Bank Accounts
Suppose you have $100,000 in savings, and you put it all in the bank. That can be considered an investment. It has essentially no risk because it is FDIC ⓘ insured, so even if the bank fails, you will get your money back. It is also liquid; you can withdraw your money at any time. If you put it in a checking account at a large bank, you might not earn any interest, in which case your return would be 0. And inflation will reduce your money's purchasing power by an average of 2-3% per year, so you'd actually be losing money.
Instead, you can put your money in a high-yield savings account. It will be FDIC insured and liquid, but the interest rate will be much higher.
Government Bonds
Government bonds are another option. Returns can be higher, but different bonds mature at different times. As of this writing, the 1 month yield is 5.386%, while the 10 year yield is 4.245%. If you invest in the 10 year bond, and you hold for 10 years, you'll get 4.245% interest; if you sell earlier, you may get less, because as interest rates increase, bond values fall. This is known as interest rate risk. The 1 month bond doesn't have interest rate risk, since in one month, the bond will mature, and you will receive the face value. But then you'll have to invest that money somewhere else, and interest rates may be lower. This is known as re-investment risk. As a rough rule of thumb, it is often assumed that short-term bonds are expected to return around 1.2% less than 10-year bonds. That is, you may get 5.386% today, but interest rates will drop, so over 10 years, this rule of thumb predicts a 10-year annual return of 4.245% - 1.2% = 3.045%. Even after inflation, this would probably be a positive (but low) return. Of course, your actual returns could be significantly less or more than this, depending on future interest rates.
Corporate Bonds
You can invest in corporate bonds and get a higher expected return; as of this writing, our corporate bonds page predicts an expected return of 5.36% (a 5.66% yield, minus 0.3% to reflect historical bankruptcy risk). But in a poor economy, they can underperform. These are also less liquid; individual bonds can be difficult to trade on the open market. Instead, you can invest in an ETF or mutual fund that will trade for you, but the fund's expenses will reduce your return. ⓘ
Gold
Gold is assumed to go up with inflation, but it can be very volatile; it can considerably underperform or outperform inflation. It is difficult to value, because there is no income like there is from bonds; so you're depending on future investors paying a higher price. Gold investors believe there are potential situations when the dollar would significantly decrease in value but gold would retain its value; that is, it is often used as a hedge against potential crises. Warren Buffett, the famous value investor, does not like gold as an investment.
Stocks
Historically, stocks have significantly outperformed bonds and cash. Aswath Damodaran, a professor at NYU, calculates an expected return for the U.S. stock market; as of this writing, he expects an Equity Risk Premium of 4.18%. If you add this to the treasury yield of 4.25%, you get an expected return of 8.43%. But it could be far more or less; the market has, at times, fallen by more than 50%.
Real Estate
Real estate is another option. You can buy a house and rent it out. You then have predictable income, to the extent that you can forecast future rents and expenses. Liquidity is lower, because it is much more difficult to sell a property than a stock. If you want more liquidity, you can buy REITS (Real Estate Investment Trusts). These are stocks in companies that invest in real estate. These are liquid because they are stocks you can sell, but like any stock, their prices can be volatile.
Conclusion
Investing is an important tool for building wealth, but there are various options, each with their own levels of risk. Investors should consider how these options that align with their financial goals and risk tolerance.