Putting your money to work for you is the goal of investing. Of course, it starts with saving — having money set aside that you want to grow over the long-term. Any money that you may require within six months to a year should be parked in cash, bank deposit accounts or money market accounts. The rest you invest.
The most common instrument that is thought of when it comes to investing is stocks. Buying stock in a company gives you an actual ownership stake. That equity share entitles you to vote in the election of directors and in other matters that are presented at shareholder meetings. Stocks can be classified by size and style. You will hear these terms used often by stock analysts and market commentators. Size is defined by the value of one share of stock, multiplied by the number of shares outstanding, called capitalization. A large-cap stock is a corporation with a market capitalization of $10 billion or more. A mid-cap stock means you are investing in a company with a market cap between $2 and $10 billion. And small-cap stocks are generally capitalized between $300 million to $2 billion. Style refers to a corporation’s earnings characteristics. If a company is seeing rapidly increasing revenue and profits, it is considered a growth stock. If you are investing in a company that has plenty of assets, solid management and future earnings potential — but whose share price has been beaten down lately – you are investing in a value stock.
Bonds are considered the “safe haven” of investing. You are actually lending money to a corporation or government and being paid interest in return. Bondholders have no ownership interests in an entity. Investing in bonds is generally considered a good way to balance the risk of a stock portfolio. But remember, the value of bonds move opposite to the direction of interest rates. When interest rates rise, the value of bonds fall. And when interest rates fall, bond values go up. Of course, varying bond values are usually just a temporary price adjustment because if a bond is held to maturity, your principal investment is returned – barring an issuer bankruptcy and default. Taxable bonds are issued by corporations, but many investors look for the tax-free interest that is paid by municipal bonds, a debt obligation issued by state and local governments. By and large muni bond holders don’t pay federal taxes on the earnings, or state taxes if the bond was issued by the state of their residence. Treasury bonds are issued by the U.S. government. The income is exempt from state and local, but not federal, taxes.
Mutual funds are among the most popular investments available. Investing in mutual funds means that you are actually buying a basket of stocks or bonds. With a mutual fund, you gain diversification due to the many investments held inside the fund. Just as with stocks, mutual funds come in an assortment of investment styles and with varying risks. And mutual funds can be professionally managed or designed to track an index. With the variety of funds comes a variety of fees, so prudent investing requires keeping a close eye on the visible – and invisible – mutual fund charges.
Exchange-traded funds (ETFs) are growing in popularity, primarily due to the combination of mutual fund-like diversification, combined with generally lower fees. Unlike mutual funds, which are priced and traded once per day, ETFs trade throughout market hours, just like stocks. Investing in ETFs seems to present nearly as many choices as mutual funds, but in reality there are over 4,500 mutual funds currently offered, compared to some 1,200 ETFs. [twocol_one]