Types of Investments

Let’s use an example to demonstrate the types of investments. For instance, pretend you are going to start a lemonade stand. You need some money to get your stand started. You ask your grandmother to lend you $100 and write this down on a piece of paper: "I owe you (IOU) $100, and I will pay you back in a year plus 5% interest." Your grandmother just bought a bond (IOU) by lending money to your "company" named Lemo. To get more money, you sell half of your company for $50 to your brother Tom. You put this transaction in writing: "Lemo will issue 100 shares of stock. Tom will buy 50 shares for $50." Tom has just bought 50% of the shares of stock from Lemo.

You sell $500 worth of lemonade. Business is good. Your costs for setting up the stand are $150, plus you pay yourself $100 for the hours you work. The company makes profits of $250.

After one year, from the $250 profits, you pay back your grandmother $100 plus $5 interest. You pay $20 to Tom and yourself, shareholders (a fancy name for owner). In business, the $20 paid to the owners is called a dividend. You decide to put the dividend money in the bank. Banking the money is a short-term investment.

This example covers three types of investments: short-term investments, bonds, and stocks. Besides these three, there are real estate (buying a house), commodities (gold and silver), collectibles (such as baseball cards), and mutual funds. Let’s examine these seven, one at a time.

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