Today, the Finance 101 series will be covering the most common types of investments: Bonds, Stocks and Mutual Funds. We will give you a high level overview of each of the investment types, so that you are knowledgeable about your investment options.
We will be covering investing and investment strategies in more detail in next week’s Finance 101 article. Take some notes City Girls! This information is crucial to assisting with your growth of financial knowledge.
A bond is a form of debt, and you are the credit issuer. Essentially, when you buy a bond, you are giving a loan to the government, a company, a city, etc. in exchange for a promise to pay at a specific date, with a pre-set interest rate until the bond is paid back.
The interest rate is determined when the bond is purchased. The interest payments, also known as coupons, are paid on a consistent basis until the bond reaches its end date. Once the bond matures, you will be paid in full for the original purchase price.
Sounds like a no brainer, right? Not exactly; you have to ensure that the bond issuer will follow through on the payment.
Typically, the less credit-worthy issuer will pay a higher yield, or interest rate on the bond. Bonds with unusually high interest rates are referred to as “junk” bonds; due to the fact that the issuer may not pay out when the bond matures.
The safest bonds are those issued by the U.S. Government. These bonds are called Treasury bonds and are considered to be risk-free. These bonds will yield a smaller interest rate, but they are guaranteed by the government.
Another important thing to note is that interest rates drastically impact bond prices.
“As interest rates rise, bond prices fall. That’s because when rates climb, new bonds are issued at the higher rate, making existing bonds with lower rates less valuable”, according to Dave Kansas, author of The Complete Money and Investing Guidebook. Fortunately, if you hold on to the bond until the maturity date, your interest rate always stays the same and you will receive the full bond amount.
Some common types of bonds include: Treasury bonds, Agency bonds, Savings bonds and Corporate bonds. For more on bonds, check out Investing in Bonds.
A stock is a form of investment that gives you partial ownership of a publicly traded company. A stock, also known as shares or equity, indicates a claim on the company’s assets and earnings.
The more of a company’s stock you own, the more of an ownership stake you have in that company. Holding stock in a company makes you a shareholder of that company. This means that you are entitled to your share of the company’s earnings, as well as any voting rights that may come with it.
Owning stock in a company does mean you are entitled to assets and voting, but it does not mean you are entitled to running the business. Annually, shareholders elect a board of directors who have the say in the company.
Unless you are a majority shareholder, the purpose of your share in the company is to earn a profit. Ideally, you purchase stock in a company for a specific price and as time goes by, the company’s stock price should rise. You earn any gains from the price you purchased the stock at to where the stock price is when you sell.
For example, let’s say you purchased 1,000 shares of an oil company, Magnum Hunter Resources (MHR). You purchased the 1,000 shares on 5/1 for a purchase price of $4.00 per share. This means that you spent $4000 and the value of your stock at the time of purchase was $4000.
It is now 12/1 and MHR’s stock price is $5.50. The value of your stock is now $5500 (1,000 shares multiplied by the current stock price of $5.50). This means that in 7 months, you earned a $1500 profit. That is the ultimate goal when investing, to earn a profit.
Unfortunately, there are times when companies go bankrupt or report negative financials. These things can drive the stock price down, resulting in a loss of your original investment.
Going back to the MHR example, if you decided not to sell on 12/1 in the hopes the stock would continue to go up, and now on 1/1 the stock is trading at a price of $3.50 per share, your initial investment is only worth $3500. This is a $500 loss. This is what makes investing in the stock market such a risk.
No one can predict what the future will be or how the market will react to certain global and economic issues.
Some companies may also offer dividends to their shareholders. Dividends can come in all types of forms and are usually profits that are paid out from the company. You have two options when investing in the stock market: short-term trading and long-term investing.
Short-term trading, or even day trading, means that you purchase a stock that you only plan on keeping for a short amount of time (a day, if you are day trading). People have made large profits and turned short term trading into a full-time career.
The safer route is to invest in a company that appears to be around for the long haul. Purchasing stock in this type of company and keeping it for years can result in good returns.
So how do you go about trading stocks? Start by researching brokerage companies (Charles Schwab, Fidelity, E-Trade, and UBS are a few of the common ones).
You can open a brokerage account with any of these firms. From there you can fund your account and start researching stocks to purchase. Keep in mind that these firms charge standard fees for trading, do your research to see what will work best for you.
Investing in stocks is risky, but the greater the risk can mean the greater return! Check out Shopping for a Brokerage Account for what to look for when looking for a brokerage account.
The last investment type we are going to discuss is the mutual fund. A mutual fund is a form of investing that allows you to place your money in a professionally managed portfolio that could contain stocks, bonds and other forms of investments.
This allows the investor to diversify their investments without the hassle of purchasing or selling individual shares or bonds. The portfolio is also managed by a professional. Fidelity and Vanguard are just a few examples of mutual fund companies.
The options are endless when deciding on the mutual fund portfolio that is right for you. Typically a mutual fund company will sit down with you and discuss your long-term goal.
Depending on the timeframe that you would like to invest, as well as the type of risk you are interested in, will help determine the best portfolios for you.
There are more fees involved when your portfolio is being managed professionally, but this allows you to take comfort in the fact that a professional is investing your money for you.
We could continue to talk about bonds, stocks and mutual funds because there is a lot of information out there. Our goal is not to overload your brain, but to inform you of the financial options that are available to you.
A lot of money can be made when you invest in stocks, bonds and mutual funds. It is important that you know where and how to make the most of the money you do have. Remember one thing though; any profits you make from investing are taxable!
On the flip side, any losses you incur for the tax year can help lower your amount owed.
What do you think about investing? Have you invested in any of the items discussed today? Do you have a question that you need answered?
Share your thoughts, feedback tips when picking out a stock or bond! We all can benefit from different views. We may even be able to pick up a few good investment options!