Investment Type
Bonds
When you purchase a bond issued by a corporation or government, you are actually loaning the issuer money. The bond specifies the amount of the loan, interest rate, how often the issuer will make interest payments to you and the date the principal of the loan must be paid in full (maturity date).
For example, you might purchase a $10,000 bond with the following characteristics:
8% annual interest rate.
Interest paid in two semiannual payments.
Bond matures in 2016, when you would get back your original $10,000 principal.
Many investors choose bonds when they want a source of current income while seeking to preserve their capital. There are many kinds of bonds, such as U.S. Treasury, U.S. Agency, corporate, municipal and zero-coupon bonds.
Bonds often are referred to as "fixed income" investments because they typically offer fixed interest payments and principal repayment. A bond may be rated by an independent rating service, such as Standard & Poor's or Moody's Investment Services, Inc. Both companies use letter grades ranging from triple-A (the highest) to D (in default) to evaluate a bond's credit quality.
Bond prices are directly affected by interest rates. Typically, when interest rates fall, bond prices rise and vice versa. That sounds contradictory to many people because a bond comes with a fixed interest rate and a fixed principal amount. The following example, which is for illustrative purposes only, may help clear up any possible confusion:
| In 1996, Investor A bought a bond from Company A as follows: |
In 1997, Investor B bought a bond from Company A, but interest rates went down: |
| $10,000 principal |
$10,000principal |
| 8% annual interest rate |
7% annual interest rate |
| Semiannual interest payments |
Semiannual interest payments |
| Principal payment comes due in 2016 |
Principal payment comes due in 2017 |
In this example, Investor A's bond is worth more money than Investor B's because Investor A is getting a higher annual interest rate for the same $10,000 investment. If another investor wanted to buy Investor A's bond, he would likely have to pay more than $10,000 because its annual interest rate is higher than the going rate at the time. If interest rates went above 8%, Investor A's bond would be worth less than $10,000 because an investor could purchase a new $10,000 bond that pays a higher rate.
Common Stocks
When you purchase the common stock of a company, you become a partial owner -- or shareholder -- of the company. The company will ask you to vote for the board of directors each year, and help determine other specific matters.
The company also may pay you dividends, which are a distribution of the company's earnings. The price of a share of a company's common stock generally changes daily. It's based on the amount of money an investor is willing to pay for the stock on that day. When the current share price is higher than the price at which you purchased shares, the value of your stock has appreciated. When the current price is lower, the value of your shares has declined.
More than 30,000 stocks are available in the United States and there are many thousands more in foreign exchange. Most common stocks are bought and sold in organized markets, such as the New York Stock Exchange (NYSE) or the NASDAQ-American Stock Exchange (AMEX). These markets report prices daily in most local and national newspapers, so you can follow the progress of the stocks you own or are interested in buying.
You can purchase stocks through brokers or in some cases directly from the issuing company. When you buy shares of a common stock, you typically are expressing a vote of confidence in the future of that company. As a shareholder, generally you hope to gain from price appreciation, dividend income or both.
Mutual Funds
It used to be that only wealthy people had the resources to hire their own personal money managers or to purchase large portfolios of stocks and bonds. Today, thanks to the popularity of mutual funds, practically anyone can benefit from a wide range of professionally managed investments.
When you invest in a mutual fund, your money is combined with the money of thousands of other investors with similar investment goals. Professional money managers use this pool of money to make a wide range of investments, such as partial ownership in many publicly held companies (stocks) and interest-bearing certificates issued by governments and corporations (bonds). A mutual fund affords you many benefits, from diversified investments to professional money management.
Each mutual fund has specific investment goals that can range from long-term growth to current income. In addition, a fund may invest in specific types of investments to reach its goals, such as dividend-paying stocks, international investments, or long-term bonds.
Owning shares of a mutual fund is similar to owning shares of stock in an individual company. The mutual fund company will ask you to vote for its board of directors each year, and to help determine other company matters. The mutual fund also may pay you dividends, which are a distribution of the company's profits.
The price of a share of a mutual fund is determined at the close of business each day. The price reflects the closing value of the all of the investments the fund holds in its portfolio on that day. Like stocks, the daily price of a mutual fund may go up or down.
