Investment options are not limited to stocks. Investors have several choices including bonds, mutual funds, exchange-traded funds (ETFs), derivative products and traditional savings accounts. The "best" non-stock investments are not necessarily the bonds or the mutual funds that had the highest returns over the last year, or even the last five years. Rather, investors should design investment portfolios to suit their individual risk tolerance level and investment time horizon.
Corporations and governments issue short- and long-term bonds to raise money from investors, who in return get regular interest payments and the principal, or face value, of the bond back on maturity. The interest, or coupon rate, of the bond depends on the creditworthiness of the issuer. For example, U.S. government bonds pay less interest than a publicly traded company because private companies are at greater risk of default than governments, especially the U.S. government. The advantages of bonds -- aside from regular interest income -- include safety and less volatility. However, the rate of return on bonds -- especially low-risk Treasury bills -- can be quite low compared to other investments.
Mutual funds sell units and use the proceeds to invest in stocks, bonds and other assets. Business newspapers, such as "Barron's" and "The Wall Street Journal," publish tables ranking mutual fund performance over time. However, investors should not base their decisions solely on historical performance; they should also take the time to review a fund’s prospectus, which describes its investment philosophy and lists key holdings. Mutual funds are best suited for novice investors and those without the time to read through company financial statements and other material before making investment decisions. The disadvantage is that mutual fund investors lose control over how and where their money is invested.
Exchange-traded funds are traded like stocks, but are not linked to a particular company. ETFs track broad market averages -- such as the Dow Jones Industrial Average or the S&P 500 -- and specific industry sectors. ETFs mirror the performance of the corresponding index. For example, the Diamonds ETF -- ticker symbol DIA on the New York Stock Exchange -- tracks the Dow Jones index. Therefore, if the Dow is up 10 percent, DIA will also be up about 10 percent. ETFs provide broad diversification possibilities at a low cost.
Options are known as derivatives because they are based on other assets, such as stocks and market indexes. An option contract gives the holder the right, but not the obligation, to buy or sell the underlying asset at a specific strike price on or before an expiration date. Investors can use options to hedge or protect their portfolio against market declines. They can also use options to speculate on market movements. For example, they could buy call options if they think the market is going up because the call option would appreciate in value. However, if the market falls sharply, the call option could expire worthless. Therefore, options represent a risk-reward tradeoff; some strategies offer high rewards and limited risk, while others offer limited rewards and theoretically unlimited risk.
Real estate, including the primary residence, could be a good non-stock investment. Other choices include CDs, money market accounts and a new business.
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