The ABCs of Investing
While some people are bewildered by the choices, many invest in mutual funds.
But with thousands of mutual funds to choose from, where do you begin? Nearly all mutual funds can be broken down into three main components – stocks, bonds and cash equivalents.
Stocks represent ownership in a company. Owners of stock are typically entitled to receive dividends (paid out as earnings) and to vote on the selection of directors and other important matters.
Stockholders own “equity” in the company. People invest in stocks because they believe the value of their investment will increase over the long term.
Lastly, it’s important to remember that stockholders share in the fortunes and misfortunes of a company. As a result, since stocks bear the greatest risk, they also offer the best historic returns.
Bonds are essentially an IOU for a loan you make to a corporation or a government. The borrower, sometimes called an issuer, promises to pay back the amount of the loan after a period of time. Depending on the type of bond, interest may be paid periodically to the bondholder, or paid all at once when the bond reaches the end of its term, or maturity. Because issuers intend to return the loaned amount to the investor, bonds tend to carry less risk than stocks and, consequently, tend to provide a lower historic return.
Cash equivalents are short-term investments with maturities of less than one year. These often include short-term government or corporate securities as well as certificates of deposit or money market funds. As these types of investments carry very little risk, these tend to provide the lowest returns.
Investment Rules of the Road
I’m often amazed that we spend countless hours learning how to drive a vehicle, navigate in difficult conditions and get safely to our destinations, while we fail to take the time to educate ourselves about the investment vehicles that will get us safely to our life’s destinations.
Here are some investing rules of the road to follow:
We’d all like to find a low-risk investment that offers high returns. Unfortunately, these are very hard to find. Most often, lower-risk investments provide lower returns; higher risk investments historically provide higher returns. The key is to strike the right balance of risk and return to meet your goals.
So what’s the right mix for you? That’s where the help of a trusted adviser can be beneficial. Recognize that it’s OK to “pull over to the side of the road” and let a professional provide guidance and help you arrive safely at your destination.