- AuthorIvan Kennedy
Ivan Kennedy has experience teaching College-level Business Management for the last 4 years. He has an MBA from the University of Kansas and a Bachelor’s degree in Business Economics. He has work experience in Business and Finance and he can relate well to any such related material.
View bio - InstructorShawn Grimsley
Shawn has a masters of public administration, JD, and a BA in political science.
View bio
Learn all about investment vehicles. Understand what an investment vehicle is, learn the types of investment vehicles, and see common investment vehicles.Updated: 11/21/2023
Table of Contents
- What is an Investment Vehicle?
- Types of Investment Vehicles
- Lesson Summary
Frequently Asked Questions
What are the 4 types of investment vehicles?
The four types of investment vehicles are ownership investments, cash equivalents, lending investments, and pooled investment vehicles. The investment vehicles are distinguished by their degree of investment risk.
What are the most common investment vehicles?
The most common investment vehicles are exchange-traded funds, mutual funds, bonds, stocks, certificates of deposit, and annuities. Each of these has its own advantages and disadvantages. They are differentiated by their risk degree and the rate of return. Therefore, investors should conduct their due diligence based on their preferences and purpose before investing in any.
What are investment vehicles?
Investment vehicles describe the financial instruments in the investments industry that provide investors with the platform of investing funds with the hope of garnering money in the future. They are basically commodities that investors use to gain future returns.
Table of Contents
- What is an Investment Vehicle?
- Types of Investment Vehicles
- Lesson Summary
An investment vehicle describes a financial instrument or commodity as an asset, which helps investors choose the best-fit investment strategies that fit them with the expectation of gaining returns in the future as income and capital gains. They are products and services of the investment industry that help investors understand their structure and create value for them. Investment vehicles are categorized into two, with each category having its subscriptions. The two categories are; direct and indirect investments.
Direct investments occur when investors purchase a company and government-issued securities or purchase real assets. In contrast, indirect investments emanate from investors giving investment companies money to invest in securities for them. The primary purpose of investment vehicles is to assist investors in the transfer of cash into the future and earn them at an increased value at that future date. They operate by enabling investors to gain money through investing their money in securities and assets for a profit in the future.
Safe investment vehicles describe the contractual agreements between an investor and a company they are investing in that grant them rights to an equity stake in the future. However, the stake due is not determined at the time when the investor is conducting their initial investment.
CDs & Annuities
The certificate of deposit and the annuity are examples of investment vehicles. A certificate of deposits infers an account in which individuals and companies put a fixed amount of savings for a fixed period and receive interest on the savings in return. Certificates deposit depict low risks of investment which translate to relatively low returns. They operate through receiving customer deposits as savings with a maturity date when the customer should withdraw and receive their interest along with their earlier investment. The purpose of CDs is to provide returns to depositors who deposit their money for a fixed period with minimal risk. Financial institutions use this money to lend borrowers at an interest, hence generating money. Examples of CDs are Jumbo CDs, broker CDs, and liquid CDs.
An annuity infers the investment that insurance companies offer to pay an investor an amount of income when they retire. It provides guaranteed income upon retirement to mitigate the risk of consuming up savings before retirement. Annuities operate by allowing the investor to pay periodic premiums over their working years and then receive income upon retirement. This happens through the accumulation of income in the form of premiums to the insurance company, and then the investor receives the income due after the accumulation phase. Examples of annuities are pension payments, mortgage payments, and savings deposits.
Stocks & Bonds
A stock is a representation of the shares owned by a stockholder in a company. Stocks depict the fraction of a company that an individual or entity owns. For one to own shares in a company, they purchase stocks that entitle them to own a percentage of the company based on the value of the stock they bought. Stocks serve the purpose of raising business capital for expansion or establishing new projects. An example of this security is the common stock.
Bonds are loans in large amounts from an investor to a borrower. A bond is an investment vehicle because it allows investors receive interest payments from borrowers who pay them periodically as agreed between both parties. Bonds work through issuance by organizations or governments as the borrowers and then repay their face value with interest at the agreed maturity date. An example of a bond is the municipal bond. Municipal bonds are not usually entitled to federal income taxation because state and local governments regulate them. Bonds aim to help an investor generate income, while stocks protect money from market conditions like inflation and build an investor's savings.
Mutual Funds & ETFs
Mutual funds describe an investment strategy where investors merge their money intending to purchase securities. Mutual funds do not conduct investments in one company but rather diversify the risk by investing in various securities. Mutual funds play the role of diversifying an investor's portfolio by investing in several securities for the investor at a fee, which is meant to cater to the administration and management costs. The money market fund is an example of a mutual fund.
Exchange-traded funds describe the investment strategy that pools securities like mutual funds and other assets together and trades them like stocks towards increasing diversification. ETFs operate through receiving securities to sell and buy in the exchange market at a particular index after investing. The purpose of ETFs is to invest in various securities hence lowering costs and diversifying a portfolio to mitigate financial risks of losses.
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The most common types of investment vehicles are ownership investments, cash equivalents, lending investments, and pooled investment vehicles. These investment vehicles are differentiated by their degree of risk when investing in them. Some portray high risks, and others have low risks, distinguishing them from each other.
Ownership Investments
Ownership investments explain the initiative of an investor to purchase company stocks and mutual funds so as to own a portion of the company. Through the purchase of the investments to become a partial owner, the investor has an influence on the decisions made in the company regarding the investments. Characteristics of ownership investments are volatility due to unpredictable price movements, ownership where the investor can own a portion of a company they have invested in, and a high investment risk hence a higher potential of returns.
The advantages of ownership investments are equity, where an investor owns a portion of the company they invest in, appreciation, where the investment builds up over time, and deductions in tax, where lesser charges are charged. However, ownership investments are disadvantageous in that they depict a high risk of losses where it is possible to lose the investments. They are also volatile, which is why they are risky due to instability in the movement of prices.
Lending Investments
Lending investments describe the investment that investors engage in through investing in a financial institution like a bank. This investment vehicle works by allowing customers to deposit money in a bank for a particular period and earn profits through interest. Banks use this money to grant loans and generate money through interest. These investments are characterized by low risks and low rewards. The advantage of lending investments is that they have lower risk; hence the potential of a loss is minimal or zero. However, they are disadvantageous because they have minimal monetary returns in an interest form. They are also faced with the interest rate risk, which can lower the investment value hence little interest earnings.
Cash Equivalents
Cash equivalents are a representation of the value of cash in the hands of the company or individual or the assets that are as good as cash. They operate by investing them over a short-term basis as money market funds. They are characterized by high liquidity, which explains their ability to be converted into cash quickly. They also depict good credit quality, which means they are readily used to repay loans and grants.
The advantages of cash equivalents are that they are easily transformable into cash, hence the ability to meet needs on time, aid companies to acquire financing, and generate revenue as an interest to the investing company. However, they depict low return rates when invested to generate interest. They can also translate to a loss of revenue when the company invests in them due to prevailing market conditions and not out of necessity.
Pooled Investment Vehicles
Pooled investment vehicles describe the amalgamated collection of funds amongst various investors towards investing in the purchase of shares. It is a collective pool of funds raised by several investors. It works by combining the total funds from individual investors and investing them in a common investment platform. The proceeds thereof are used to pay back the investors based on their proportions in the fund. Pooled investments are characterized by minimal investment fees and a broad portfolio of investment opportunities to select from. Pooled investments are advantageous in that they give companies a negotiating power because of the participation of a group of buyers. They also promote diversification due to access to various investment opportunities, mitigating financial risks. However, pooled investments are disadvantageous in that they limit individuals' opinions and control regarding their decision-making on the investments.
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Investment vehicles are the platforms that the investment industry provides to investors so that they can put their funds and expect to receive a higher amount than the face value in the future. Investment vehicles are categorized into direct and indirect investments. Direct investments are further classified into stocks, bonds, certificates of deposits, annuities, and real estate. In contrast, indirect investments are subdivided into exchange-traded funds and mutual funds. Annuities are investments offered by insurers to provide investors with an income upon retiring after paying premiums. Exchange-traded funds (ETFs) are characterized by various investments diversified as a portfolio for trade like stocks or bonds.
Mutual funds are an investment classification that entails the pooling of investments for diversification to create a portfolio managed by a team of managers that are paid, for management purposes, by the investors. Certificates of deposits are investments where individuals deposit a fixed amount of money into a bank for a fixed period, after which they can withdraw it with interest. Bonds are a type of loan to an issuer that seeks to undertake a project or other operations and then pays the lender, the bondholder, periodic interest payments. Municipal bonds are the types of bonds that are not subjected to federal income taxes due to their regulation by state and local governments.
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Investment Vehicles Defined
Bethany is a financial planner working with Charles, a new client. She is helping Charles develop a diversified portfolio of investments utilizing different investment vehicles that meet Charles' investment objectives and tolerance for risk. An investment vehicle is simply an investment product that is offered to investors that provide the chance for investors to earn a return, or profit, on the product purchased. Let's take a quick look at some of the major investment vehicles that Bethany can recommend to Charles.
CDs & Annuities
Two investment options that have limited risk of loss are certificates of deposit and annuities. If you invest in a certificate of deposit (CD), you give the bank money in return for a certificate that entitles you to earn a particular rate of interest payable at the end of the investment period. You are pretty much lending the bank your money. While it's possible to withdraw money from a CD, there will be penalties assessed. The maturity date of a CD varies; some may be cashed in without penalty in one month while others may not mature for years. CDs issued by your bank are insured by the Federal Deposit Insurance Corporation (FDIC) and are, therefore, safe so long as the CD and other accounts at the bank don't exceed the FDIC limits of $250,000. Charles will be taxed on the interest earned.
An annuity is a financial product, usually sold by an insurance company, that is structured to pay a regular income to its owner commencing upon a certain date, typically upon reaching retirement age. Charles will only be taxed on income generated by an annuity when he starts receiving payments or if he makes a withdrawal of funds from the annuity. Consequently, the value of the annuity grows quicker because the tax is deferred. Annuities may be fixed, which provides a fixed payment, or variable where the payments may be greater or lesser than a fixed annuity, depending on how well the investments with the annuity perform. Annuities are relatively low-risk investment vehicles, but that also means there's a lower potential return (i.e. profit).
Stocks & Bonds
Charles may also invest in stocks and bonds. A stock is a certificate representing an ownership interest in a corporation. Stocks are traded on various markets known as stock exchanges. Stocks can be categorized as either common stock or preferred stock. Holders of common stock may receive dividends, which is a distribution of profits from the company, and are entitled to vote at shareholder's meetings. On the other hand, holders of preferred stock get preferential treatment on payment of dividends and upon the distribution of the company's assets at liquidation over common stockholders. However, preferred stock usually does not come with voting rights.
Let's talk about taxes. Charles' income from dividends will generally be taxed in the year he receives them, and he'll also have to pay taxes on any gain from the sale of stock in the year he sells his shares. For example, if Charles bought 100 shares of AnyCorp, Inc. for $20 a share and sold them a few years later at $25 per share, he'd have to pay tax on the $500 gain (i.e., {(25-20) *100}).
While history tells us that stocks are probably one of the best, if not the best, investments for the long-run, prices can be quite volatile in the short-term, and investment in stocks do pose a substantial risk, especially if your portfolio of stocks is not diversified.
While stocks are about ownership, bonds are about debt. If Charles invests in bonds, he is basically loaning money to the entity offering the bonds. Bonds offered by the United States Government are known as treasury bonds, treasury notes, or treasury bills, depending on how long it takes before they mature. Bonds offered by state and local governments are known as municipal bonds. Municipal bonds are exempt from federal income tax and are usually exempt from most state and local taxes too. Bonds offered by companies are known as corporate bonds.
Mutual Funds & ETFs
Mutual funds and exchange-traded funds (ETFs) are also viable investment vehicles for Charles. A mutual fund is an investment fund consisting of money pooled together by many investors and is professionally managed by professionals. Mutual funds may focus on stocks, bonds or other types of securities. They may be very narrowly focused, such as focusing on small tech companies, or broadly focused, such as trying to mimic the performance of a market index, like the Standards & Poors 500. While they provide professional management and ease of diversification, mutual funds tend to be more costly to invest in because you have to pay for that professional management. Charles will be taxed on any distributions or realized gains upon sale of his mutual fund shares.
Exchange-traded funds (ETFs) are securities that are traded on an exchange just like a stock or bond. Like a mutual fund, ETFs hold a portfolio of investments like stocks, bonds, commodities and others. They are often designed to mimic the performance of a stock or bond index. Since ETFs are freely traded, they are easier to liquidate than mutual funds and usually come with lower fees as well. Gains realized from dividends or sale of an ETF are subject to tax.
Lesson Summary
An investment vehicle is a financial product offering investors a chance to earn a profit. CDs are offered by banks and are federally insured by the FDIC. Annuities are generally offered by insurance companies and offer either a fixed or variable payment upon retirement. Stocks represent ownership in a company while bonds are debt instruments. Mutual funds utilize the pooled money from investors and are professionally managed. Exchange-traded funds consist of a portfolio of investments, and the shares can be traded publicly on an exchange similar to stocks or bonds.
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