August 6, 2009
We have already mentioned that there are many ways to invest your money. Of course, to decide which investment vehicles are suitable for you, you need to know their characteristics and why they may be suitable for a particular investing objective.
Grouped under the general category called fixed-income securities, the term bond is commonly used to refer to any securities that are founded on debt. When you purchase a bond, you are lending out your money to a company or government. In return, they agree to give you interest on your money and eventually pay you back the amount you lent out.
The main attraction of bonds is their relative safety. If you are buying bonds from a stable government, your investment is virtually guaranteed, or risk-free. The safety and stability, however, come at a cost. Because there is little risk, there is little potential return. As a result, the rate of return on bonds is generally lower than other securities.
When you purchase stocks, or equities, as your advisor might put it, you become a part owner of the business. This entitles you to vote at the shareholders’ meeting and allows you to receive any profits that the company allocates to its owners. These profits are referred to as dividends.
While bonds provide a stable stream of income, stocks are volatile. That is, they change in value on a daily basis. When you buy a stock, you aren’t guaranteed anything. Many stocks don’t even pay dividends, in which case, the only way that you can make money is if the stock increases in value – which might not happen.
Compared to bonds, stocks provide relatively high potential returns. Of course, there is a price for this potential: you must assume the risk of losing some or all of your investment.
A mutual fund is a collection of stocks and bonds. When you buy a mutual fund, you are pooling your money with a number of other investors, which enables you to pay a professional manager to select specific securities for you. Mutual funds are all set up with a specific strategy in mind, and their distinct focus can be nearly anything: large stocks, small stocks, bonds from governments, bonds from companies, stocks and bonds, stocks in certain industries, stocks in certain countries, etc.
The primary advantage of a mutual fund is that you can invest your money without the time or the experience that are often needed to choose a sound investment. Theoretically, you should get a better return by giving your money to a professional than you would if you were to choose investments yourself. In reality, there are some aspects about mutual funds that you should be aware of before choosing them, but we won’t discuss them here.
Alternative Investments: Options, Futures, FOREX, Gold, Real Estate, Etc.
So, you now know about the two basic securities: equity and debt, better known as stocks and bonds. While many investments fall into one of these two categories, there are numerous alternative vehicles, which represent the most complicated types of securities and investing strategies.
The good news is that you probably do not need to worry about alternative investments at the start of your investing career. They are generally high-risk/high-reward securities that are much more speculative than plain old stocks and bonds.