There are a variety of different types of investments you can put your money towards in the world today–from alternative investments, such as gold and real estate, to stocks and bonds. Today, I am just going to get your feet wet with describing the basics of three major types of investments: stocks, bonds, and mutual funds.
Stocks, also known as shares or equity, represent your partial ownership in a company. This gives you rights to give your say on who is hired to the board of directors, for example. It also gives you the right to reap the rewards of a company earning profit and have partial ownership of all their assets. The profits that are paid out are given under the name “dividend.” So, you will earn dividends if a company is profitable. Unfortunately, however, not all companies pay out dividends, so the only way you could earn money from a stock is if it increases in value over time. This might seem like it is too good to be true, but keep in mind that one is not guaranteed any money after purchasing a share in a company. The stocks could decrease in value and you would lose money. The stocks could increase in value and you would earn money. The company could make a profit and you could earn dividends. The company could go bankrupt and you could earn nothing. Stocks are quite risky but offer the potential of great rewards.
Today, brokers have a hold of your stock certificates, or documents that verify your ownership of a share in a company, so that it can be easily traded or sold at any time. In the past, someone would have to physically hand his/her stock certificate to a broker in order to start the process or trading or selling his/her stock.
Debt-financing is when an entity takes on debt and promises to pay back exactly what they loaned plus an interest rate. An example of this is a bond. Equity-financing is when an entity gives partial ownership to numerous people so that they can use their money to operate their company. Financing is essential for businesses who are looking for finances to operate their company. By issuing stocks and bonds, companies offer an array of options for people who are looking to invest their money in their companies.
Bonds are safe investments, compared to stocks, as they guarantee a certain amount of money will be paid back to you by a certain date. These are low-risk, because the ROI (return on investment) is usually quite low. A bond is a type of security which provides a fixed-income, or agreed upon specific amount, in return. If you invest $100 into a bond, which can either be issued by governments or companies, with a coupon (interest rate) of 6%, for example, you will earn $6.00 annually over the course of, let’s say, 10 years until the bond reaches its maturity date, or when the initial amount invested is given back to the investor by the issuer (the government or company that you purchased debt from).
Mutual funds were created with the idea in mind that not all investors are created alike. A majority of investors on the market do not have the financial know-how to invest in the absolute lowest risk and highest reward entity. Because people often have little time to invest in digging through financial literature and market trends, mutual funds come in to save the day. Mutual funds are a collection of stocks and bonds, managed by financial professionals so that the investor does not need to do as much work themselves. This seems like a foolproof way to invest and earn money, but as with all investments, there are costs. If a mutual fund depreciates in value over time, there is no guaranteeing you will get that money back. There are also annual fees incurred by using this professional service to manage a portfolio of stocks and bonds for you.
Come back in a couple of weeks for the next part of my series on the basics of investing money!