There are many different possible investments. We choose among them on the basis of many characteristics, such as average returns, riskiness, liquidity, tax treatment, income, convenience, minimum investment, and trading costs. Following traditional financial theory, we put a lot of focus on risk and return, which are arguably the most important considerations for large institutional investors. For individual investors, taxes, liquidity, and minimum investment are also very important.

Of the assets listed above, the bonds, such as the Treasury issues, municipal bonds, and corporate bonds, have relatively low average returns but also relatively low risk. Cash, which can refer to actual currency and demand deposits or also to short-term investments that bear interest as in a cash management account, also has low risk and low average return. Tips are the new Treasury securities that are indexed to inflation and are nearly riskless in terms of spending power.

The other assets listed above have higher expected returns, but also higher risk. We will see later that risk matters at the portfolio level, not at the level of the individual security. For example, an equity portfolio has substantial risk and so does a short position in S&P 500 index futures. However, a combined portfolio of the two may have very little risk because the futures price and the value of the equity portfolio tend to move in opposite directions.

The assets vary in their liquidity, that is, the ease with which they can be converted to cash without significant loss of value. Cash is (by definition) completely liquid, and Treasury securities are very liquid. Common stocks of companies traded on major exchanges are fairly liquid, especially for large companies, but corporate bonds and privately-placed equity are usually much less liquid. Mortgage-backed securities and real estate are typically illiquid.

The tax treatment of various assets is complex. We will return to this topic, but for now we note that Municipal Bonds have significant exemption from taxes, which is why they are still attractive to high-tax investors although their returns are small.