Chapter 3: Types of Investments

There are many types of investment vehicles, with the most common being securities: cash, stocks, and bonds.

Cash Equivalents
Cash – called “cash equivalents” – is comprised of several types of low interest, low risk investment vehicles. Though considered safe, the low return means interest may not keep up with inflation. Having a portion of your savings in cash is a security measure. Not suitable for long-term growth, their purpose is to preserve principal and offset the risk of stocks and bonds. Cash equivalents include:

• Insured Savings and Checking Accounts. Available through financial institutions, these accounts are a safe place to “park” your money.
• Money Market Funds. These mutual fund invest only in short-term (one day to one year) debt obligations such as Treasury bills, certificates of deposit, and commercial paper.
• Money Market Accounts. An insured savings account that shares some of the characteristics of a money market fund, money market accounts offer many of the same services as checking accounts although transactions may be limited.
• Certificates of Deposit (CDs). Offered by financial institutions, CDs are short- or medium-term (anywhere from three months to six years), interest-bearing, insured debt instruments.

Stocks
A share of stock represents a percentage of ownership in a corporation. Companies issue stock to get investment money to build or expand their business. Investors purchase stock because of the potential for capital appreciation.

The two basic types of stock are “common” and “preferred.” If you own common stock you may vote on such issues as the company’s business objectives and board members. Preferred stockholders do not have voting rights, but instead may receive dividends – quarterly payments made from the company’s earnings.

Stocks are an important part of many people’s investment portfolio because they have the greatest potential to make the most amount of money. However, stocks are volatile: one day your stock may be worth more than what you paid for it, the next, less.

Stock prices are determined by supply and demand for the stock, the stock market and economic conditions, the company’s performance, and even by other investor’s expectations and emotions.

Bonds
A bond is a loan to a company or government, with you, as the bondholder, being the lender. Organizations issue bonds when they want to raise funds. In exchange for the loan, interest (called the coupon) is promised. There are investment grade bonds (low risk, low coupon) and junk bonds (high risk, high coupon). Maturity time frames (the date you get your initial investment back) vary from one to thirty years, depending on the issuer. Some bonds are callable – where, under certain conditions, the issuer has the right to redeem the bond (buy it back) prior to its maturity date. The bond market is complex, and most beginning investors will stick to the “buy and hold” method.

The Federal government, states, cities, corporations, and many other types of institutions sell bonds. There are short-term bonds which have a maturity of six months to a year, intermediate bonds which mature between two to five years, and long-term bonds, maturing between ten and thirty years.

Mutual Funds
Mutual funds pool investors' money to purchase stocks, bonds, or cash equivalents in order to meet specific investment objectives. With the intention of meeting those goals, mutual funds may invest in one or a combination of these types of securities..

Mutual funds have several advantages over “stock picking.” Diversification is built into them (making them less risky than investing in a single company), and they are professionally managed. Annual management fees are included in their cost. Some funds charge a fee (called a load) when they purchase or sell shares, which can be as high as 8.5 percent of the total account value.

There are thousands of mutual funds from which to choose. Equity funds invest in stocks, fixed-income funds in bonds, and money market funds in cash equivalents. Balanced funds invest in both stocks and bonds. Some mutual funds invest only in foreign companies, others only in socially responsible firms (no tobacco, firearms, or alcohol companies, for example). Others concentrate on specific sectors – such as transportation, technology, health care, and utilities. The variety of mutual funds is enormous.