Life is full of tough choices. One of the toughest is how and where you invest your hard-earned money. To make the best decision for you, you need a basic understanding of how the most popular investment vehicles work. Here’s a crash course.
Bonds: When you buy a bond, you’re essentially lending your money to an organization. It could be a government, municipality or company. In return for your loan, they agree to pay you interest on your money until the bond matures. At maturity they’ll pay you back the principal. If you aren’t the original holder of the bond, you may gain or lose money on the purchase price of the bond itself.
The main attraction of bonds is their relative safety. If you buy bonds from the U.S government, for example, your investment is basically risk-free, but your returns will be low, too. When you buy a bond from a large company with a stable history, these are often called investment grade bonds. Generally they’ll offer slightly higher returns than comparable government bonds, but with increased risk. Overall, compared to other securities, well-rated bonds carry lower risk and lower returns.
Stocks: When you purchase stocks in a company, you become a part owner of the business. Although you won’t have anything to do with the actual running of the company, if it is a dividend-paying stock, you’ll receive a share of the profits that the company pays to its owners. This is not always the case though - some stocks don't pay dividends. Then the only way that you can profit is if the stock increases in value and you sell it.
Compared to bonds, stocks fluctuate in value regularly, sometimes on a daily or even hourly basis. The upside of that volatility is the potential for high returns. But you’ll have to take on the risk of losing some or all of your investment.
Mutual funds: When you buy into a mutual fund, you’re pooling your money with other investors to pay a fund manager who’ll select and manage a group of securities for you - typically a mix of stocks, bonds and other smaller investment vehicles. You share in any growth or loss, and in any income paid by the fund’s investments. Each fund invests in anywhere from a few dozen to several hundred different securities, so it’s a convenient way to diversify. Because mutual funds are run by a pro, they’re a great way to invest if you don’t have the time or experience often needed to choose individual investments. Details about a fund’s investment strategy, the fund manager, fund expenses and more can be found in the fund’s legal disclosure, called a prospectus. It’s a good idea to read it thoroughly before investing.
Exchange-Traded Funds (ETFs): Like mutual funds, ETFs are a collection of securities like stocks and bonds. A key difference is that they trade like stocks on an exchange. Similar to mutual funds, when you buy an ETF, you’re buying shares of the overall fund rather than actual shares of the individual securities. Compared to regular mutual funds their management fees may be lower. As with a mutual fund, read the fund’s prospectus thoroughly before you invest.
Money Market Funds: Money market funds are generally lower risk and tend to invest only in fixed-income securities. So they’re a good bet if you want to put money away for a rainy day and still see some growth on it. As with any other investment, there is still a degree of risk.
Certificates of Deposit (CDs): If you’re looking for an even safer option than a money market fund, a bank CD might be for you. Typically issued by banks, a CD is a fixed deposit that the bank will hold for an agreed length of time in return for a competitive rate of interest. CD’s are insured by the FDIC, so they’re very safe if you stay within the coverage limits, but your returns will be comparatively low.
Ask questions. Lots of them.
There’s no substitute for good advice. Now that you’re armed with a little knowledge, talk to a financial advisor to help you create a sound investment strategy that fits your financial goals and needs. They’ll be able to point you in the right direction.
You should consider the investment objectives, risks, and charges and expenses of mutual funds or ETFs carefully before investing. The prospectuses/prospectus summaries contain this and other information, which can be obtained by contacting your local representative. Please read the information carefully before investing
This material is provided for general and educational purposes only; it is not intended to provide legal, tax or investment advice. All investments are subject to risk. We recommend that you consult an independent legal or financial advisor for specific advice about your individual situation.
The tax information herein is not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding tax penalties.
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