Stocks, bonds, bank accounts or IRAs? How do you choose?
With several types of investments to choose from and also thousands of sub-categories under them, finding the most suitable investment choice can be a daunting task.
First off, the main consideration in any long-term investing decision is the rate of return expected from it. At times though, investing in short-term investment can enhance your wealth even if the returns are not as high as you want them to be. You can select from among these common short-term savings vehicles:
Short-term savings vehicles
Bank savings account: The most resorted to savings medium availed of by people, which provides small returns but better than keeping your money at home where it could be stolen or spent easily.
Money market funds: These funds are a type of special mutual funds that are invested in exceptionally short-term bonds. Money market fund shares are always valued at $1 whereas most mutual funds can have uncontrolled prices. Although they pay higher returns compared to bank savings accounts, they provide lower returns than certificates of deposit.
Certificate of deposit (CD): You can also open a CD, a special account made at a bank or another financial body which has an interest rate often at par with short- or intermediate-term bonds, depending on the CD’s deposit duration. The depositor receives regular returns on interest until the account matures, at which time the original amount deposited is returned together with accumulated interests incurred. Oftentimes, certificates of deposit through banks are insured to a maximum of $100,000.
Our company is partial to stocks as investment vehicles over the rest of the long-term choices since stocks have statistically provided the best rate of return in an investment. The most common long-term investing vehicles are as follows:
Long-term investing vehicles
Bonds: There are various forms of bonds. Also known as "fixed-income" securities, bonds generate a “fixed” or set income value each year when it is sold. They are very similar to CDs as investments options although they are issued by the government or corporations and not by banks.
Stocks: Stocks allow an individual to own a portion of a company or business. A single stock share represents an investor’s proportional stake or share of ownership in a business. As the business grows, the worth of an investor’s share in it also increases. Otherwise, the worth decreases.
Mutual funds: Mutual funds are vehicles which allow investors to combine their money to buy bonds, stocks, or any vehicle the fund manager considers viable. In short, you turn over the control of your money to a professional who now has the final say as to the performance of your investment. In most cases, these "professionals" play with your money by underperforming the market indexes to their own benefit.
Several special plans are intended to build retirement savings; and many of these plans permit an individual to transfer money directly from his or her paycheck prior to taxes. In support for this plan, companies sometimes match the amount transferred, or even a small portion of that amount, as their goodwill contribution to their employees’ future. In some countries, the company share is required by law at specific amounts or percentage of salaries. In some cases, these plans can provide an “advance” out of the plan to purchase a house or pay for college, at no interest. In cases where an “advance” is not allowed, an individual can take out a loan from the account, or take a low-interest secured loan using the retirement savings as security. The rates of return on these plans vary according to the type of vehicle invested in, whether bonds, stocks, CDs, mutual funds or any mix.
Individual retirement account (IRA): This type of plan lets you invest some money into a tax-deferred retirement fund – which means you will not be taxed unless withdrawals are made or before the fund matures. Regular income-tax rates apply once money is withdrawn, which are higher than capital-gains tax rates. All IRAs are considered as specialized accounts and not as investments, allowing the account holder to invest freely in any manner. Some or all of your IRA payments may be considered tax-deductible, if the holder satisfies certain requirements.
Roth IRA: Unlike the previous IRA plan, this type of retirement account requires no tax payments up-front on contribution. Rather, it provides full exclusion from federal taxes when cash is withdrawn to purchase a first home or pay for retirement. Likewise, a Roth IRA can also be utilized for other specific needs, for instances, unreimbursed medical expenses and education minus any penalty. Nevertheless, earnings which are withdrawn will be taxed as income if your age is below 59 ½ years. Only qualified taxpayers can avail of a Roth IRA; that is, if you join corporate retirement plans and are disqualified from deductible payments to the conventional IRA.
401(k): Employers provide this retirement savings vehicle, whose name is taken from the section of the Internal Revenue Code which allows it. This plan has the tax advantages and the potential benefit of corporate matching (as mentioned above), making the 401(k) a potential choice for many people.
403(b): This is the nonprofit version of a 401(k) plan. Local and state governments also provide a 457 plan.
Keogh: A specialized form of IRA that serves simultaneously as a pension plan for a self-employed individual, who has the capacity to pay substantially higher contributions permitted for an IRA.
Simplified Employee Pension (SEP) plan: This is a special type of Keogh-individual retirement plan designed to allow small businesses to provide retirement plans (for their employees) that are slightly easier to manage compared to conventional pension plans. Either the employer or the employees can participate in a SEP.
Investing in stocks
Stocks deserve a closer look as they have been known in the past to offer higher returns compared to bonds and other vehicles. As mentioned, the investor becomes a part-owner of a company. Since it was started by Dutch mutual stock corporations in the 16th century, the present-day stock market allows business-owners to raise capital to run their enterprises with the money provided by investors. This scheme makes the investor a stakeholder or a virtual co-owner of the business itself. As a token of that ownership, the stock certificate is given to the investor to serve as specialized financial "security," or financial instrument attesting to or securing an investor’s claim on the assets and income of a business concern.
The most common type of stock is, as expected, the common stock. The common stock provides an ideal vehicle for most individuals, since anyone can participate – whether you are young, old, discriminating or easy-go-lucky. There is practically no restriction imposed against anyone who wants to buy a common stock. Nevertheless, the common stock does not merely consist of a document but an actual part-ownership of an existing business operated by real people. Through buying stocks, you participate in a very satisfying process of producing wealth which is unmatched by any other means, except probably by a fortunate turn of events, such as inheriting the wealth of a departed relative you have never met or striking a substantial oil deposit in your backyard.
In short, shareholders are part "owners" of a company’s assets and its generated income. As the business grows with more acquisition of more assets and enhanced income-production, the worth of the company also increases. This results in the increase of the total value of the business as well as in the proportional value of the stock in that business.
As stakeholders and part-owners of the company, shareholders are given the right to vote or elect the members of the board of directors. This board serves as a set of officers who supervise the primary decisions made by the company managers. These directors are the main players in the corporations throughout the world and possess great power, as a result. For instance, boards can choose to allow a company to invest in itself, pay dividends to investors, buy other businesses or assets, or repurchase stocks from its investors. Although the top managers of a company (those who operate the business from day-to-day) can provide some advice or guidelines to the board, the final decision belongs to the board members. Oftentimes, the board also has the power to hire and fire the company managers.
All is not perfect even in owning stock in a company that is doing well at any given time, as running a business has certain risks. Obviously, being part-owner or a company means sharing in the potential risks latent in any business operation. If the business does not make a positive income, the shares of stock will decrease in value. In case the business folds up, the stock will then become worthless.
Different types of stock
Sometimes, companies can opt to focus the voting privilege of a company to cover only a particular type of stock, limiting the majority of shares to only a select group of investors. As an example, a family business seeking to raise capital by selling equity might create a second type of a stock which they already control and has, for instance, 10 votes for each share, while they release to others another type of stock that allows only a single vote per share.
This, for many people, is not an acceptable deal; and so, many investors usually avoid companies having such multiple types of voting stock. Media companies often have this form of structure which had its inception in 1987.
That is why you hear of Class A and Class B shares, because of this selective classification of stocks.
What happens from now on?
That is about all you need to know for now about the fundamental classes of investment options available to you. You can start impressing some of your friends and relatives about your newfound knowledge on stocks. Use the basic terminology as well as the essential principles of becoming a shareholder of a company to tell them how they can also join in the experience of investing. Most of all, tell them of the potential rewards you and they can expect from buying stocks while reminding them of the greater risks they will encounter compared to merely keeping their money in a bank. In the end, what you will decide to do with your new knowledge will be up to you.
We encourage you to take avail of our newsletter services for a month for free. Our contributors may have diverse views on many issues; but this fact helps to provide you with a wide selection of insights and perspectives on how to succeed in investing. We have a disclosure policy which allows us to be fully transparent in all transactions.
Planning and setting objectives
Investing is a long-term process, like planning a long vacation. Ask yourself these questions before you embark on this endeavor:
• What is your destination? (What financial goals do you have?)
• How long is your vacation? (What is your time frame in investing?)
• What should you bring along? (What investments forms will you choose?)
• How much gas do you need to use? (How much will you invest to achieve your goals? How much can you invest a regular plan?)
• Do you have stopovers on the way? (What short-term financial expenses do you have?)
• How long is your vacation? (Will you have to retire using your investment?)
• If you run out of gas because you frequently stop to rest and drive through the night, you are bound to spoil your vacation. So it is if you do not save enough money, if you invest haphazardly or fail to invest at all.
Answer these questions judiciously and honestly. Muddling through this process of self-examination and preparation will cause you to see the finer points of investing which requires a lot of number-crunching. Calculate accurately how much a college education will cost and how much you will need during your retirement years. It will not only be satisfying to know that you can actually attain your destination, you will also remain aware of what you must do along the way in order to fulfill your future goals.
In case you are panicking because you consider numbers to be a great challenge, do not be alarmed. There are user-friendly online interactive calculators which can assist you estimate your financial goals. As we said, the more realistic and detailed your figures are, the greater the chances of setting and realizing viable goals.
How stock trading works
Now that you have set your finances in order and you have also established definite financial objectives, you are now ready to learn how to begin investing. With mutual funds, the procedure is quite easy: Call the fund company and request them to open an account for you. Dealing with stocks can be a more challenging endeavor.
Stocks are traded at various stock exchanges. The major US exchanges are the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), and the Nasdaq Stock Market. Although there are differences in the manner these exchanges perform their trading, the process itself of buying and selling shares requires a similar process in all of them.
Stock exchanges are where buyers and sellers connect. The buyers make a "bid", which is the price at which they are willing to buy a share, while sellers “ask” the price at which they are willing to sell their shares. The “spread” is the difference of the two prices, which often goes to the professionals who manage trades in exchanges.
Depending on the amount of shares traded on a certain day or period, the value of the spread will vary. For traded stocks which are making brisk sales, the spreads will tend to be very small because of competition. Conversely, the spread will tend to be large for stocks being traded thinly, to cover the risk that exchange professionals have to take.
Any investor can establish a bid or ask price by placing orders to buy or sell at a certain price. Such orders are referred to as “limit” orders. Exchange professionals monitor these "open" orders, executing them when conditions are satisfied and utilizing these orders to determine preference for the stock.
Buying stocks is primarily done through brokerage accounts. You may choose between two options: the overly high-priced full-service brokers, or the discount broker. To know more about picking brokers, visit our Broker Center, comparing brokers and choosing the best one who can open an account for you.
The dangers of margin
Through a brokerage account, you can choose between a cash account or a margin account. A cash account allows you trade using available money you are willing to invest. A margin account allows you to buy stocks using other people’s money – which you borrow. Margin accounts can be attractive for obvious reasons; however, the risks can be significant.
Some brokers will advise you to opt for margin as they have hidden interest in doing so, using greater "buying power" as a lure. Remember that what you increase is not only your "borrowing power" but also the risks you take.
Moreover, brokers get some of their killing through collecting interest on margin loans – a sort of commission. The two words (broker and commission) were born twins! As investors borrow more money to buy more stocks, the brokers (who promote margin accounts) collect more commission fees. The broker possesses complete control over the loan collateral, while having the power to interfere and compel you to sell stock in case you are defaulting on your loan. Warning: Margin will milk you dry while the broker gets all the milk and honey.
Direct investment plans (DIPs) and Dividend reinvestment plans (DRPs)
If you think you are not up to opening a brokerage account yet, other plans can provide a different but sure way to buy stock. Nicknamed by investors as Drips, these plans let shareholders buy stock from a company, directly and at low costs or fees. Only a few firms offer these plans, although they are best for investors who only have limited amounts of money to spend at regular periods.
Now that you have gained enough background information on how to start investing in stocks, as well as what your financial goals are, how much money you will need to invest, how long it will take to recover your investment, the next move is to begin considering where to invest and the kind of potential gain you hope to make.
You can get more info from our newsletter services which we offer free for one month. Our contributors may have diverse views on many issues; but this fact helps to provide you with a wide selection of insights and perspectives on how to succeed in investing. We have a disclosure policy which allows us to be fully transparent in all transactions.
Sparks Corporation welcomes you to a promising world of wealth-building opportunities. As a leading provider of wealth management services and investment solutions, we have proven our capability to surmount dire economic obstacles and successfully benefited our global clients in prudently managing their assets through efficient planning in order to achieve their financial goals.