Different Types of Investments (10/3/05)

I'll preface this banker story by telling you that I'm not a licensed investment professional. My specialty is lending money. However, I work with highly qualified CFA's with many years of experience. As a result, I've gained a solid surface of knowledge regarding a number of different investment options. If you need a tangible measure of the breadth of my knowledge on this topic, I'd rate it a five on a scale from 1 to 10. Whereas, your average high school graduate may be a 1 and Warren Buffet is a 10 (if you know who Warren Buffet is, you're an automatic 2 on the scale).

These are all investments that anybody can purchase from the appropriate investment representative or, in some cases, you can purchase online. I'll give you a brief explanation of the investment, the typical purchaser based on risk tolerance, and some buzz words associated with the investment you can use to impress your friends. As I've mentioned in the past, the recipients of the Banker's Story all vary in knowledge. So, forgive me if I bore you with things you already know. Here goes....

Stocks
Stock, or shares, represent ownership of a corporation. There are a few different types of stock, but the most common is.....common stock. Stock prices go up and down all the time and are traded on one of the various exchanges, such as the NASDAQ or NYSE. Since owning stock means you're a partial owner of the corporation, you get to help make the decisions, sort of. Each share represents one vote when issues are put to a stockholder vote. Sounds cool, huh? Not really. Unless you own a lot of stock, your vote has very little impact. In some cases, one person calls all the shots because they may own at least 50.1% of the shares issued by that corporation. On top of that, they send you big (and boring) annual reports about the company and periodic voting cards, and who needs more mail.

Many of you have probably heard of the DOW Jones Industrial Average. The DJIA is simply a market indicator. It's made up of 30 major industrial companies and is probably the most reported indicator in the media. The fluctuations in the DJIA do not necessarily correlate with the fluctuations of the stock you own.
Risk: Stocks are the riskiest type of investment. If you own stock in one company, and that company goes out of business, your stock will become worthless (See: Enron). However, if that company performs very well and the stock triples in value, you'll make a lot of money. It's a calculated gamble in almost all cases.
Buzz words: Many investors refer to stocks as securities. Stocks also have classifications based on company size. There are small-caps, mid-caps, and large caps. The stocks in the DJIA are called Blue Chips. So if some wealthy fellow corners you at a cocktail party and tells you how his large caps are doing, he's talking about the stock he owns in a large company.

Mutual Funds
There are three different types of mutual funds: stock funds, bond funds, and money market funds. Stock Funds are investments that own a collection of various stocks. When you purchase shares in a stock fund, your money is pooled with money from other investors to create greater buying power than you would have if you had invested on your own. Since a stock fund consists of many stocks (sometimes hundreds), you're less dependant on one or two companies. If one company within the fund goes out of business, you won't lose all your money. Each stock fund is run by a fund manager, which identifies and publishes certain objectives for the fund so you can choose which one is best for you. Some funds are more aggressive and riskier than others. For example, one fund may have a conservative strategy and invest only in large, well known, and stable companies, such as Coca-Cola and Proctor & Gamble. For the explanation of a bond or money market fund, simply read this paragraph again and insert the word "bond" & "money market" respectively where the word "stock" is.
Risk: The investment diversification of the mutual fund is the most important characteristic. Because of this, typically a mutual fund is less risky than individual stock. Bond funds and money market funds are even less risky.
Buzz words: There are over 10,500 different mutual funds on the market today. They all have names which typically include the name of the company that runs the fund and the type of fund it is. For example, you could purchase shares of the Commerce Mid-Cap Growth Fund. A shrewd investor may refer to them simply as, funds.

Bonds
A Bond is debt issued to the public. This is an instrument an entity uses to acquire large sums of money. The most typical bonds are corporate bonds and government bonds (also referred to an Municipal Bonds). For example, St. Louis County may issue a bond offering to the public so they can obtain funds to build a new highway. When you own a bond, it will pay you an interest rate and have a maturity. For example, you could buy a $1,000 bond which pays an interest rate of 4% with a 10 year maturity. This means, you would be paid $40 per year for ten years, and get $1,000 at maturity. Simple, huh? Bonds can get complicated when they are bought or sold prior to maturity. Then you need a really smart person to valuate them.
Risk: Like stocks, the issuer of a bond can go out of business and take your money with them. At issue, all bonds are given a rating based on the strength of the entity issuing them. The higher the rating, the safer the bond. Believe it or not, government bonds typically have high ratings than bonds issued by companies. A bond's initial rating can be upgraded or downgraded at anytime. Overall, bonds are safer than both stocks and mutual funds.
Buzz words: Government bonds are sometimes referred to as Muni's (this stands for Municipal Bond). Bonds of the lowest ratings (below C by Moody's), are called Junk Bonds. Bonds rated higher (BBB or higher by Moody's) are called Investment Grade Bonds.

Savings Bonds
Perhaps, these are among the safest investments. However, they don't pay much. There are two main types of savings bonds, I and EE Bonds. The interest rate paid on these bonds change semi-annually. Both of these types of savings bonds will earn interest for 30 years, but the interest isn't paid to you until you cash them in. You can purchase them at any bank and a small certificate will be mailed to you by the United States Treasury. If your grandmother bought you a savings bond when you were born, you can go to http://www.ussavingsbonds.gov/ to find out how much it's worth.
Risk: Very low, almost none. Unless, of course, the Federal Government goes out of business.
Buzz words: Savings bonds aren't "cool" to own. As a result, there's no buzz word to impress your friends.

Certificate of Deposit
These are issued by a bank. They too are a very safe investment. They vary in maturity length. The longer the term, the higher the interest rate. A 30-day CD pays a lower interest rate than a 12-month CD. Both tend to pay a higher interest rate than a savings account since you're giving up access to them. When you purchase a CD, you can't cash it in until maturity. Otherwise, there will be a small penalty. These are good investment choices if you have a chunk of money that you'd like to set aside for a year before using it as a down payment on a house. While you'll earn a little interest, you'll also avoid losing any principal such as the probability of investing in stocks or stock funds. If you purchase a $10,000 CD for 12 months at 3.5%, you'll cash it in at maturity for $10,350.
Risk: Very low, FDIC insured by banks.
Buzz words: None, unless the word "CD" counts.

These investments are most common. If you're interested in knowing more about other investment options such as foreign currency, futures, options, or commodities, let me know and I'll answer some questions on an individual basis or get you in touch with a licensed professional.

Again, let me know if you (a) want me to take you off the recipient list and (b) if you would like me to address certain topics in future stories. I also accept comments regarding the stories. It would make me feel good about myself if you (a) actually liked this story or (b) cared to read it at all.