There are many investment products out there, and understanding them all can be complicated. Today we will look at some of the most common investments and how they work.
A stock is an investment that represents an ownership stake in a publicly owned corporation. Corporations issue stock in order to raise capital, and those who buy the stock share in the gains and losses that the business experiences. When a privately held corporation first “goes public”, they have what is called an initial public offering, or IPO. After the IPO, the stock is traded on an exchange such as the New York Stock exchange or the NASDAQ. The price of the stock is then decided by the supply and demand of those buying and selling the stock. Investors can profit by selling shares of stock for a higher price than they paid. Some companies pay out their earnings in the form of dividends; this is a way for investors to realize a profit while still holding their shares.
Bonds are similar to stocks in that they are issued in order to raise capital. They differ in that a stock is a form of ownership, whereas a bond is a form of debt. When an institution issues a bond, they borrow money at a stated interest rate from the investor who buys the bond. Take for example a ten-year $1,000 bond with a 5% interest rate. The investor will be paid 5% of $1,000 per year for ten years, and at the end of the term the issuer will return the original $1,000 to the investor. The guaranteed rate of return and return of principal makes bonds a low-risk investment. The riskiness of bonds can vary, though; U.S. treasury bonds are considered the safest type of bonds because they are backed by the full faith and credit of the U.S. government, while a “junk” bond issued by a corporation with a low credit rating may carry a high risk of default.
A mutual fund is an investment where the money of a large group of investors is pooled in order to achieve a stated investment objective. Mutual funds can either be actively managed or passively managed. In an actively managed fund, the fund manager picks individual investments to be bought and sold on behalf of the fund. Because of the high amount of attention given to the fund’s management, actively managed funds have a high expense ratio, which is a portion of the fund that the fund manager keeps as compensation for management costs. Passively managed funds typically mirror the performance of an index, which is a basket of securities designed to serve as an indicator of the performance of an entire market. The S&P 500 is a popular stock market index, and there are many passively managed funds that are based upon it. Because passively-managed funds are easier to manage, their expense ratios tend to be extremely low.
Precious metals such as gold and silver have been a popular investment for centuries. There are several ways to invest in these metals. The simplest way is to purchase gold or silver from a reputable dealer and hold the metals in your possession. The metals can be kept in a safe deposit box, or with a service that specializes in precious metals storage. Those who want to benefit from precious metals investing without physically owning the metals can buy stock in gold and silver mining companies. There are also mutual funds that specialize in this area. Many investors are drawn to gold and silver because of the security that they provide during times of economic tumult. According to investor Andreas Christian, “Precious metals have been a trusted investment for centuries. Over time, there is simply no other instrument that can parallel the security and value provided by gold and silver.”
We have discussed the most popular types of investments here, but there are plenty of others to look into if you are interested in learning more. There are real estate investment trusts (REITs), direct participation programs, money market instruments, and complicated derivatives products which can be based on the performance of completely separate investments.