It’s time to have an overview of the various types of market investments that are available to the public.
Unlike savings vehicles such as short-term U.S. Treasury securities, all investments involve risk of loss and are not guaranteed. However, they also offer the potential to make substantial gains.
The following is an overview of the most popular investment vehicles:
Topic 1: Stocks
A stock represents a share in the ownership of a company as well as a claim on part of the company’s earnings and assets; the person who owns the stock is a shareholder. Shareholders are allowed one vote per share of the stock they own to elect members of the board of directors; this is also known as exercising voting rights.
There are two types of stocks — common and preferred.
Here’s an example of a common stock:
You’ve purchased 100 shares of XYZ Corporation at $10 per share for a total investment of $1,000. A year later, the price of the stock increases by $20 and now trades at $30 per share with open gains of 200%.
At this point, you decide to sell your 100 shares. Your gain before broker fees and commissions: $2,000.
Now, let’s take into account dividends. This stock not only goes up 200%, but has paid four quarterly dividends of $0.50 per share. Your total return, including dividends: $2,200.
Here’s the calculation:
- Purchase:
- 100 shares x $10 per share price = $1,000
- Sale:
- 100 shares x $30 per share price = $3,000
- Stock ($) Gain:
- Sale ($3,000) – Purchase ($1,000) = $2,000
- Dividends:
- $0.50 x 4 (quarters) = $2.00
- $2.00 x 100 shares = $200.00
- Total gains:
- $2,000 + $200.00 = $2,200.00
Preferred stocks represent partial ownership in a company. However, unlike common stock holders, preferred stock shareholders do not have voting rights. Also, preferred stocks pay a fixed dividend that rarely varies.
Another benefit of being a preferred stock holder is that, in case the company declares bankruptcy, preferred stock investors have greater claim on the company’s assets.
Some of the most well-known websites to learn more about stocks and look up current stock information are Yahoo! Finance, Bloomberg, Reuters, MSN Money and Google Finance.
If you don’t have time to look at your investments at least once a month, maybe individual stocks aren’t for you. Bonds and/or funds may be more your style.
Please note: Shareholders have limited liability, meaning in case the company has outstanding debts they are not held personally responsible for paying its outstanding debts.
Topic 2: Bonds
If you’re running a corporation or a government entity, and you want to borrow money from the public, you can issue bonds.
And, conversely, if you’re looking to earn a fixed income on your money, guaranteed by a corporation or government, you can loan them your money by buying their bonds.
In short, bonds are IOUs issued by a corporation, federal or local government for a period of time at a specified interest or coupon rate in order to raise capital by borrowing. The investor who buys the bond is the creditor. The entity that issues the bond is the borrower and promises to repay the interest (usually semi-annually) as well as pay back the principal at maturity.
Investors who purchase bonds should research the issuer of the bond and view their bond ratings before making a purchase.
What can bond ratings tell you? In the investment community, two prominent bond ratings agencies — Standard & Poor’s and Moody’s — established a ratings scale that alerts investors to the overall health of the issuer. Though the lettering in their scales differs, they tell the same story.
Just remember, if a bond is rated a triple B or better, it is classified as an investment grade bond and is relatively safe. If the bond is double B or lower, it’s considered a “non-investment grade” or a junk bond.
There are several different types of bonds. They include corporates, municipals, and Treasuries.
Corporate bonds are debt instruments issued by corporations. They tend to pay a higher rate than municipal or government bonds because of their risk.
Municipal bonds are issued by city, state and local governments to raise capital to finance government projects, such as building highways and bridges. Because municipals are not taxed on the federal level they tend to pay a lower rate when compared to Treasuries and corporates.
Treasury bills, notes and bonds are the safest unsecured bonds because they are backed by the full faith credit of the U.S. government. (Bills mature within one year; notes, between 1 and 10 years; and bonds, in 10 years or more.)
Please note: As a bond holder, you do not have ownership rights to the issuing entity; however you have a higher claim to an issuer’s assets and income than a stock shareholder if the company declares bankruptcy. Also, bonds that pay high returns are generally riskier investments.
Type 3: Bond Funds
Bond funds are mutual funds that invest in fixed-income securities. They are diverse, professionally managed investments that are considered favorable investment vehicles for individuals seeking a steady monthly income or a place to keep emergency savings. In short, bond funds are known for their convenience and liquidity. They are potentially good investments for those in or nearing retirement.
The investment focus of bond funds varies. For example, some bond funds may invest primarily in government or municipal bonds while others may focus on corporate or zero-coupon bonds. No matter its investment focus, bond funds are in no way risk free.
Before investing in any bond fund, do your homework, read the fund’s prospectus and up-to-date shareholder information.
To research bond funds online you can go to Morningstar.com or Yahoo! Finance.
Topic 4: Mutual Funds
Mutual funds are a compilation of stocks, bonds and other securities that allow investors to pool their money together. The money they invest is overseen by a fund manager who directs the pooled monies into various investment vehicles. In turn, each investor owns shares in the fund. If you’re seeking diversification, liquidity and simplicity, then consider mutual funds.
Topic 5: Exchange Traded Funds (ETFs)
An exchange traded fund is a fund that tracks an index or asset class, but trades like a stock. Because it trades like a stock, an ETF can be bought or sold anytime during trading hours through a broker.
There are ETFs to fit virtually all investment types. Are you looking to invest in large U.S. companies? How about the biotechnology sector? Maybe gold is on your radar. Whatever your preference, if the asset class is publicly traded, there’s more than likely an ETF available for purchase.
Plus, ETFs offer multiple advantages:
- Diversification
- Convenience
- Low minimum investment
- Minimized costs
- Potentially minimized brokerage commissions if you use a discount or online broker
- Transparency: ETFs list what they own on a daily basis via their websites
- Tax advantages
- You can use “stops” to protect your principal and your profits
- You can use limit “buy” orders
For more information on ETFs, check these websites: Morningstar and Yahoo! Finance, as well as the exchange sites for the NASDAQ or American Stock Exchange.
