Are we putting enough money aside and hoping that the money will be there when we need it?
Is there an art/science behind the investment world?
Hopefully the information below helps you understand what each of the areas discussed are and how they work. If you have an investment portfolio then you most likely fall under the following categories below.
If you don’t have an investment portfolio as of yet then what are you waiting for?
You will find having an investment in your own financial future makes perfect wealth sense
When advisors discuss investing with clients, they are primarily talking about using the different markets to invest surplus cash for long-term growth of wealth. There are three areas of investment that most individual investors will fall under when investing for the future.
The trading of stocks, bonds, and mutual funds, impacts the financial wealth of the world economy.
Examples of how capital markets work can be traced back to early hierarchy of our civilization. The capital markets were developed as a way for buyers to buy liquidity. In Western Europe, where many of our ideas of modern finance began, those early buyers were usually monarchs or members of the nobility, raising capital to finance armies and navies to conquer or defend territories of their own. Many devices and markets were used to raise capital, but the two primary methods that have evolved into modern times are the bond and stock markets.
So, what are stocks and bonds?
Bonds are considered debt. The bond issuer borrows by selling a bond, promising the buyer regular interest payments and then repayment of the principal (amount paid) at maturity (a set date in the future). If a company wants to borrow money, it could just go to one lender and borrow the money. But if the company wants to borrow a large sum, it may be difficult to find any one investor with enough capital and the inclination to make such a large loan, thus taking all the risk as the only lender. In this case the company may need to find a lot of small lenders who will each lend a little money, and this can be done through selling of bonds.
A bond is a formal contract to repay borrowed money with interest (often referred to as the coupon) at fixed intervals. Corporations and (e.g., federal, municipal, and foreign) governments borrow by issuing bonds. The interest rate on the bond may be a fixed interest rate or a floating interest rate that changes as underlying interest rates, rates on debt of comparable companies continually change. (Underlying interest rates include the prime rate that banks charge their most trustworthy borrowers and the target rates set by the Governments Financial Benchmark or The Federal Bank.)
There are many features of bonds other than principal and interest, but this is the easiest explanation that at least shows how they work. Because of the diversity and flexibility of bond features, the bond markets are not as transparent as the stock markets; that is, the relationship between the bond and its price is harder to determine
Stocks are shares of ownership. When you buy a share of stock, you buy a share of the corporation. The size of your share of the corporation is proportional to the size of your stock holding. Since corporations exist to create profit for the owners, when you buy a share of the corporation, you buy a share of its future profits. You are sharing in the fortunes of the company.
Unlike bonds, however, shares do not promise you any returns at all. If the company does create a profit, some of that profit may be paid out to owners as a dividend, usually in cash but sometimes in additional shares of stock. The company may pay no dividend at all, however, in which case the value of your shares should rise as the company’s profits rise. But even if the company is profitable, the value of its shares may not rise, for a variety of reasons having to do more with the markets or the larger economy than with the company itself. Likewise, when you invest in stocks, you share the company’s losses, which may decrease the value of your shares.
Corporations issue shares to raise capital. When shares are issued and traded on a public market such as a stock exchange, the corporation is “publicly traded.”
Only members of an exchange may trade on the exchange, so to buy or sell stocks you must go through a broker who is a member of the exchange. Money Managers – who work for big conglomerates brokers will manage your account and will offer varying levels of advice and access to research for a commissionable fee. Most members of the exchange have Web-based trading systems which can be easily accessed by the public so that you can buy and sell at a fraction of the cost of working with a Money Manager these discount brokers offer minimal to no advice or research which creates the platform for minimal trading fees.
What are Mutual Funds?
Mutual Funds, and Index Funds
A mutual fund is an investment portfolio consisting of securities that an individual investor can invest in all at once without having to buy each investment individually. The fund thus allows you to own the performance of many investments while actually buying and paying for the transaction cost of buying only one investment. Mutual funds have become popular because they can provide diverse investments with a minimum of transaction costs. In theory, they also provide good returns through the performance of professional portfolio managers.
An index fund is a mutual fund designed to mimic the performance of an index, a particular collection of stocks or bonds whose performance is tracked as an indicator of the performance of an entire class or type of security.
Mutual funds are created and managed by mutual fund companies, by brokerages or even banks. To trade shares of a mutual fund you must have an account with the company, brokerage, or bank. Mutual funds are a large component of individual retirement accounts and of defined contribution plans.
When corporations or governments need financing, they invent ways to entice investors and promise them a return. The last thirty years has seen an explosion in financial engineering, the innovation of new financial instruments through mathematical pricing models. This explosion has coincided with the ever-expanding powers of the computer, allowing professional investors to run the millions of calculations involved in sophisticated pricing models.
The Internet also gives amateur investors instantaneous access to information and accounts.
So, in conclusion the ways that capital can be bought and sold is limited only by the imagination below you will find a brief recap of how each investment works in its simplest form. We hope this has made investing easier to understand. Again, this is the very basic understanding of investing as there are more complex explanations to each of the following.
- Bonds are
- a way to raise capital through borrowing, used by corporations and governments;
- an investment for the bondholder that creates return through regular, fixed or floating interest payments on the debt and the repayment of principal at maturity;
- Stocks are
- a way to raise capital through selling ownership or equity;
- an investment for shareholders that creates return through the distribution of corporate profits as dividends or through gains (losses) in corporate value;
- traded on stock exchanges through member brokers.
- Mutual funds are portfolios of investments designed to achieve maximum diversification with minimal cost.
- An index fund is a mutual fund designed to replicate the performance of an asset class or selection of investments listed on an index.
- An exchange-traded fund is a mutual fund whose shares are traded on an exchange.