Here’s a summary of the 5 types of financial markets where a person can invest, since some terms sometimes get mixed up and we can’t always tell certain concepts apart, and they’re always worth knowing.
I’ll list them in order from lowest return to highest return, but always remember that the higher the return, the higher the risk, logically.
1. The money market
In this market, large amounts of money are bought and sold every day. It’s focused on the short term: you can earn a return on your money over periods of 1 day, 3 days, 2 weeks, 1 month… up to roughly 18 months.
Obviously this market isn’t designed for individuals, since very large amounts are traded. It’s aimed at large companies:
- Some need immediate cash for the coming weeks or months for various reasons, so they buy money and pay interest on it.
- Others have surplus cash and sell or lend that money in exchange for interest.
The companies that use these services are large corporations whose financial workings leave them with millions sitting idle in their accounts that they won’t need for another 5 days. In this market, they have the chance to earn a return on those 5 days.
Because it’s essentially a risk-free investment, the return is usually low, although it pays off well for the huge sums traded.
2. Capital markets: fixed income (bonds)
In this market, the issuer’s debt is traded. The issuer can be a private company or the government of any country. To understand what investing in this market involves: it’s simply a loan we make to the issuer, for anything from 1 year to, sometimes, 30 years.
The issuer pays us interest on that “loan”, and when our bond (debt) contract ends, it returns the amount we originally put in.
This investment is considered safe, as long as the bond we buy comes from an issuer that remains solvent over the years.
3. Capital markets: equities (shares)
This is what’s commonly called “investing in the stock market”. I won’t go into much detail about this market, since we’ve covered it in several articles. Read a related article on stock market investing.
If investing in bonds means investing in the debt a company or government issues, investing in shares means investing in the company’s equity. The stock market offers a higher return than bonds, but also a higher risk of losses.
In fact, studies show that over 10 years, as of today, stock market investment has been more profitable than bonds by a crushing margin.
4. The currency market
This means investing in the value and exchange rate of a country’s currency. This market moves trillions of dollars every day. It’s certainly a market with high returns, and some would say even more profitable than the stock market, but what really stands out is its risk rather than its returns, because of the extremely high volatility it brings.
91% of this market is dominated by the dollar, the euro, the pound and the yen. With the new opportunities technology gives us, these days you’ll know this market as forex. Read more about investing in forex. One clear drawback of investing in the currency market is how little preparation most of us have for it.
See also: The 15 most common and serious mistakes we make when investing in the stock market
That’s why we’ll have to put our money in the hands of third parties, which some people will like more than others. It’s a market that moves very fast, and over the long term it’s completely unknown territory for most analysts. Some won’t agree with this statement, and I respect their disagreement.
5. The derivatives market (futures and options)
As the name suggests, these are products derived from the other markets:
- Currency futures and options
- Stock futures and options
- etc.
When you invest in a stock future, you can make a profit even when the share price falls. This market is by far the most profitable, but as you know, it’s also by far the market where you can lose everything fastest.
It requires knowledge of all kinds of financial products and markets. Anyone who invests in derivatives clearly needs to know what they’re doing, and even then they can end up with losses. Read more about investing in derivatives.
And these are all the markets available to invest in. There are no others. In the end, it comes down to investing in fixed income, with a minimal return but guaranteed payment, or investing in equities, with risks you have to accept.
If you want to multiply your capital considerably, you’ll need to turn to equities, but always with the knowledge needed to manage the risk, to the point that by taking a long-term approach to equities you minimise risk and achieve a very high return.
Further reading
- Why the stock market is the most profitable investment
- Serious mistakes you should always avoid when investing
- Free beginner’s course on stock market investing
Featured image: Dick Thomas Johnson, CC BY 2.0, via Flickr.
