Working your way through complicated investment terminology.
Okay, you have now decided that you have the means to look at investing as described in Financial investment ABCs – Take control. You have your emergency fund in place, your debt has been eliminated, and you want to take the plunge into those waters that only the brave dare. So let’s start with some basic definitions of the terms “experts” toss around as if we should all know these.
First let’s take a look at the term Stocks. In a general sense, when you purchase stock in a company, you are purchasing a piece of that company. If that company does well your return will be determined by how much of the company you own.
If you do decide to purchase stock, you have a chance to make money in one of two ways.
First the company can decide to distribute some of the company’s profits to its shareholders as dividends, which means you get a check for what your investment represents.
Second is of course, if the value of the stock rises, you may be able to sell your stock for more than you paid for it. The flip side is that if the company loses money, you stock loses value.
Companies tend to offer one of two types of stock: Common or Preferred.
Common stock is generally what most people are referring to when they use the term “stock”. By far the majority of stock is issued is in this form.
Common stock represents your portion of ownership in a company and your portion of its profits. Common stock holders get one vote per share to elect the board members.
Traditionally, common stock, because of the growth in the company, gives you higher returns than almost every other long-term investment. Remembering the risk/reward ratio we talked about in Financial investment ABCs – Take control, the higher return comes with the most risk. If a company goes bankrupt and liquidates, the common shareholders will not receive money until the creditors, bondholders and preferred shareholders are paid.
Preferred stock also is ownership in a company but usually doesn’t come with the same voting rights as common stock (although this often varies with each company). The biggest thing to know about preferred stock is that you are usually guaranteed a fixed dividend as long as the company exists.
Common stock does not have this feature. The down side is that the company has the option to purchase the shares from you whenever they decide it is their interest to do so, but usually there is a premium paid to you for this.
Stocks can be in high risk/high return companies, or can be with solid, low risk companies. They can be volatile or can be relatively low risk. So you can tailor stock investment into your own profile for risk and reward.
Next let’s look at Investment Bonds.
Investment bonds are basically an IOU from a company, a municipality, utility, foreign governments or entities, and the national government. Bonds can be held for as short as a year or as long as ten years. They can be tax exempt of taxable. And, like stocks, can be relatively safe (Investment Grade) or high risk (Junk Bonds).
Usually a bond pays a dividend or interest on some sort of regular schedule like quarterly or semiannually, but some pay all interest at the bond’s maturity. While this interest is the primary way to earn income from bonds, bonds also tend to fluctuate in value and you can profit from selling your bonds if the value increases .
While there are risks in investing in bonds, their regular income from interest is attractive for us, Silver Surfers. Of course a bond issuer can default on payment (which we’ve seen with General Motors, Chrysler, and some cities in the United States as well as threatened in some European countries), by and large they are less risky than stocks.
What about Mutual Funds?
Mutual funds are a tool that allows you to invest in almost anything including stocks, bonds, money markets, commodities, precious metals, etc., etc. or a combination of some of these. And you do this by pooling your investment with that of myriad other investors under the direction of a fund manager who has a specific investment strategy that appeals to you and your fellow investors.
Typically mutual funds consist of ownership in many different securities. This allows you the ability to diversify your risk and portfolio with a single purchase of part of the mutual fund. You are also buying into the expertise of the manager of that fund. Your fund manager buys and sells securities with the idea of beating some benchmark, like the Dow Jones or S&P 500. Some mutual funds only invest in securities within those benchmarks.
I would caution you that as with any investment, you carefully research what the fund’s investment objectives are, what risk is involved, what the fees and expenses are for you and the track record of the investment fund manager.
Personally I prefer some sort of mutual fund over investing in a single company because with mutual funds, the return can be high, but the risk of me losing 100% of my investment is greatly reduced.
That is a very basic overview of the more commonly used terms for investments.
As with any investment there is great risk and almost all companies have a statement like this “there is no guarantee of a profit or any way to insure against a loss. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful”.
Take it from someone who knows the adverse side of risk and consider this warning to be gospel when you are considering and investment of your hard earned assets.