We all have heard people talking about how they have invested their money.  There are those who invest short-term in order to get a little interest before making a large purchase.  Then there are those who invest long-term for things like retirement.  One thing that most people don’t discuss is what they are investing in.  For most people, that is a very difficult question.  You always hear about the typical stocks and bonds, but do you know how they work? Did you know there are other options other than stocks and bonds? Here is a list of a few basic investments, as well as a few you may not have heard of. 

 

Stocks

Definition – Stocks are probably the most well known type of investment.  When you purchase a stock, you become an owner of the issuing company.  That ‘stock’ allows you to vote on matters brought up by the company.  You also are entitled any profits that the company makes and issues to its owners.  These profits are given to its shareholders in what’s called dividends.  Not all companies pay dividends. 

Stocks offer a decent reward, but they come with risk.  That risk is due to its volatility.  There are times that you could own a great company such as Google, but if the economy is hurting Google’s stock may go lower.  Stock prices can be influenced by daily activities that really have no relevance to that company, but because that issue might not bode well for the world, it will lower the stock price.  These fluctuations are very common.  That is the risk/reward of stocks.  In order to avoid these short-term price swings, many advisors suggest holding stocks for a period of 1 year or longer. 

How to Purchase Stocks - One common question that people have is how they can purchase stocks.  There are a few different ways.  The most common ways are through a brokerage firm such as E-Trade or Fidelity.  Another way is through a financial advisor.  Either way will generally cost you.  An advisor will generally charge you a fee for suggesting what to invest in.  When you purchase stock on your own at a brokerage firm, their will be a commission.  These commissions will generally range from $3-$15 per trade. 

 

Bonds

Definition – Bonds are the other most common form of investment.  Bonds are an investment that is linked to debt.  When you purchase a bond, you are loaning money to a company, municipality, or even government.  The bond issuer will then pay the bond holder interest and eventually pay back the money initially borrowed. 

Bonds are viewed as one of the safest investments you can own.  If you buy a bond from a stable government, there is little chance that you won’t get paid back so it is practically risk-free.  As with the old saying, where there’s risk there’s reward.  The safer the bond, the lower the interest will be.  So buying a US bond won’t earn you a tremendous amount of interest.  Because bonds are safer, they tend to offer lower returns than other securities. 

How to Buy Bonds – Bonds can be purchased through brokerage firms, bond brokers, and through an advisor.  Government bonds can generally be purchased directly from their treasury online.  Just like stocks, there usually will be a commission that is charged. 

 

Mutual Funds

Definition – One of the best investments for anyone who wants something simple are mutual funds.  Mutual funds are a collection of stocks and bonds all tied into one investment.  When you purchase a mutual fund, you are allowing the fund manager to pool your money with other investors and let him manage your investment.  Mutual funds are usually pegged to mimic a certain investment.  The most common example is the S&P.  There are numerous mutual funds you can purchase and their primary goal is to directly reflect what the S&P does.  Other examples are mutual funds containing only large cap stocks, small cap stocks, technology stocks, and so on.  There are mutual funds for any type of investor. 

Mutual funds tend to be the most common type of investment for the average investor.  Most people don’t have the knowledge or time to choose where to invest their money.  When you purchase a mutual fund, you are hiring a professional to manage your money in hopes that they can do a better job than you.  While this is not always the case, mutual funds tend to be a good investment.  Make sure to spend time when choosing a mutual fund and make sure it has your goals in mind. 

How to Purchase Mutual Funds – Mutual Funds can be purchased just like stocks.  You can buy them directly using a brokerage firm, an advisor can purchase them for you, or some mutual funds can be purchase directly from the issuer.  Mutual funds tend to have higher fees because they are being managed.  You will usually see an annual fee charged that goes to management and marketing costs. 

 

Exchange-Traded Funds

Definition - Exchange-traded funds or ETF’s are a lesser known investment.  ETF’s are securities that track an index or commodity and can be traded just like stocks.  A common ETF is the S&P spider which has a ticker symbol SPY.  The benefits of ETF’s are that you get diversification, but lower fees because it is not managed. 

How to Buy ETF’s – Just like a stock, ETF’s can be purchased from a brokerage firm.  You will pay a commission anytime you buy or sell the ETF. 

 

Options

Definition – The last type of investment I will mention are options.  Options can be difficult to understand, and they are one of the most risky investments out their.  You can gain or lose a lot of money very quickly.  An option is a contract between a seller and a buyer.  The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security at a certain price (strike price) during a certain period of time or a specific date (exercise date). 

If you are purchasing a call, you want the stock price to go up.  What you are essentially doing is setting up an agreement that you can buy a certain stock at a certain price.  Lets say AT&T is selling for $30, and you want to purchase a call option.  You would purchase that call option at its strike price.  Let’s say the strike price was $1 for a June 2012 call option.  When you buy options, generally you are purchasing a contract for the right to buy 100 shares.  The price of this option would be $100.  Options generally expire the 3rd Friday of every month.  You would hope that the price of AT&T’s stock exceeds $31 ($30 stock price + $1 strike price) by the third Friday of June.  Let’s say the price is $32 when the option comes due.  That would mean you could buy 100 shares of AT&T for $31 even though the stock is selling for $32.  You could obviously not do this, and lose money (I say this because you have the right, but not the obligation to buy).  In this case it would be foolish because you have made money. 

Let’s say that when the option comes due, the stock is selling for $29.  You could buy 100 shares for $30, and be down the $100 you spent but now own the shares of AT&T.  Or you could just say that you don’t want the shares, and be down the $100 you spent.  I hope that helps explain why you have the right, but not the obligation when purchasing options.  That can be difficult to understand. 

These are some of the most common vehicles for investing money.  I have dabbled a little in all of these.  Investing can be fun, and it also can be very stressful.  Losing money is never fun.  While I have lost my fair share of $, I have tried to learn from each mistake.  I try to stick to a strategy when investing.  This strategy is different for each person, but is very important.  Most of my losses have come from straying away from my strategy. 

What type of security is your portfolio heaviest in?…