CuVantis Education Series
What are the two basic categories of investments?
All investments can be classified into two broad categories – fixed investments or variable investments. The terms “fixed” and “variable” refer both to the principal amount of your investment and to the return you earn on that principal. In a fixed-rate investment, your principal is guaranteed and will not fluctuate in value. In a variable rate investment, your principal amount may fluctuate up or down. Additionally, the return you receive on your investment may also be fixed or variable. In a fixed-rate investment you know before you invest exactly what the return on your investment will be, whereas with a variable-rate investment, your return is unknown.
Why would someone invest in a variable rate investment?
While the advantage of fixed-rate investments is that they have lots of guarantees and are therefore considered “safe” in regards to your principal, the disadvantage is that they typically pay a lower interest rate and are therefore subject to purchasing power risk – the risk that your money won’t buy as much in the future as it does today. Conversely, while variable-rate investments carry risk to both your principal and earnings, they provide the potential for higher returns and therefore the potential to keep pace with inflation and taxes which will help you maintain your lifestyle in the future.
Are all variable rate investments risky?
Many people view investment risk as all or nothing – it’s either full of risk or has no risk. The reality is that variable-rate investments are available with varying degrees of risk – some very low and certainly some that are very high. It is often helpful to imagine the investment world as a linear spectrum. Fixed-rate investments basically anchor the left side of the investment risk spectrum. As you progress to the right the different types of investments continue to increase with greater degrees of principal risk.
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The information presented here is for educational purposes only and should not be considered financial, tax or investment advice. Please consult a qualified professional.