There are countless varieties of investment vehicles, from antique coins to exotic derivates. But for most people, the four key investment holdings are stocks, mutual funds, bonds, and real estate.

Stocks. A stock is an ownership interest in a company. When you buy a stock, you become a business owner, and the value of your ownership stake will rise and fall according to the success of the underlying business.

Stockholders are entitled to the profits, if any, generated by the company after everyone else—employees, vendors, lenders—gets paid. Because stockholders only get the profits left over after everyone else is paid, they shoulder more risk than bondholders (see below), who get paid a fixed amount regardless of how well a company does (unless it goes bankrupt). However, if a company generates lots of profits, shareholders enjoy the highest (theoretically unlimited) returns.

Companies usually pay out their profits to investors in the form of dividends, or they reinvest the money back into the business. Dividends provide shareholders with a cash payment, and reinvested earnings offer shareholders the chance to receive more profits from the underlying business in the future (perhaps in the form of future dividends and/or stock appreciation).

Mutual Funds. When you invest in a mutual fund, your money is pooled with that of other investors, and then it is managed by a group of professionals who try to earn a return by selecting stocks for the pool.

One key advantage of funds is that they can be less volatile. Simple statistics says that a portfolio is going to experience less volatility than the individual components of the portfolio. After all, individual stocks can and sometimes do go to zero, but if a mutual fund held 50 stocks, it would be very unlikely that all 50 of those stocks become worthless.

The flipside of this reduced volatility is that fund returns can be muted relative to individual stocks. In investing, risk and return are intimately correlated—reduce one, and odds are you will reduce the other. Mutual fund investors must also consider expenses. The professionals running mutual funds do not do so for free. They charge fees, and fees eat into returns.

Bonds. At their most basic, bonds are loans. When you buy a bond, you become a lender to an institution, and that institution pays you interest at a specified rate. As long as the institution does not go bankrupt, it will also pay back the principal on the bond, but no more than the principal.

There are two basic types of bonds: government bonds and corporate bonds. U.S. government bonds (otherwise known as T-bills or Treasuries) are issued and guaranteed by Uncle Sam. They typically offer a modest return with low risk. Corporate bonds are issued by companies and carry a higher degree of risk (should the company default) as well as return.

Bond investors must also consider interest rate risk. When prevailing interest rates rise, the market value of existing bonds tends to fall. (The opposite is also true.) The only way to alleviate interest rate risk is by holding the bond to maturity.

Real Estate. Most people's homes are indeed their largest investments. We all have to live somewhere, and a happy side effect is that real estate tends to appreciate in value over time. But if you are going to use real estate as a true investment vehicle by buying a second home, a piece of land, or a rental property, it's important to keep the following in mind.

First, despite exceptionally strong performance runs, real estate can and does occasionally decline in value. Second, real estate taxes will constantly eat into returns. Third, real estate owners must worry about physically maintaining their properties or must pay someone else to do it. Likewise, they often must deal with tenants and collect rents. Finally, real estate is rather illiquid and takes time to sell—a potential problem if you need your money back quickly.

Some people do nothing but invest their savings in real estate and do quite well. But just as stock investing requires effort, so does real estate investing.

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