Investments and Investment Strategy
When one goes to invest money there are a variety of invest options at their disposal. All investments, however, must be viewed from the concept of what is known as the risk to reward ratio. A risk to reward ratio compare the level of risk one takes wit their money to the level of reward one can receive. Risk is a situation in which the outcome of an investment is not certain, but the probabilities can be estimated. Return, of course, is the actual amount of money the investor receives from an investment. Investors are cognizant of the fact that financial assets are risky. Assets may fluctuate with price, or the agency that issued the asset may fail to redeem it leaving the lender with a loss. Therefore, investors demand a higher return to compensate for higher risk. Typically low risk investments receive little or limited reward. For those more adventurous investors, however, they may partake in very risky investments and have the potential to make a lot of money. Of course, since the risk is high, they may lose all of their money as well. Below you will find a list of some of the investments available to investors and a brief explanation of each. Think about each of them in terms of risk, reward ratio.
For more information, statistics and investing news try CBS MarketWatch and the Natonal Bureau of Economic Reserach. The US Securities and Exchange Commission has educational links as does the American Savings Education Council, and The National Association of Securities Dealers
Savings accounts are not typically thought of as investments, but they are. You deposit your money in a bank and they pay you interest for the use of your money. Since you make money on your deposit in the form of interest paid, it is an investment. Savings accounts are guaranteed by the Federal Government (FDIC) and thus have no risk. Correspondingly, the reward is quite low. Interest rates paid on savings accounts currently hover in the 2-3% range.
CD’s (Certificate of Deposit) and Money Market Accounts
CD’s are a very popular form of investment. They are really long term savings accounts that are locked in for a period of 3 months to 2 years. Because banks and others count on the use of these funds for a certain time period, they impose penalties when people try to cash in their CD’s early. Investors can also select the length of maturity, giving them an opportunity to tailor the expiration date to future expenditures. Since the bank is getting guaranteed use of your money for a period of time the longer the CD, the higher the interest rate. CD rates now run from 3-5 %. CD’s are also guaranteed by the FDIC and are no risk.
Money Markets are similar to CD’s in terms of security and interest rates with the exception that you are allowed to write a small number of checks against your deposit with no penalty. Money market mutual funds are businesses that collect funds from small investors and make loans in the form of CD’s to other borrowers. Investors like them because they receive higher interest than they would receive from dealing directly with banks. The downside is that FDIC insurance covers neither the jumbo CD’s nor the contributions to the funds.
Stocks are, as discussed previously, shares of ownership in a company. Stocks can be bought and sold through a stock broker over one of several stock exchanges. Buying and selling individual stocks is a risky venture, and thus the potential for reward is high. You want to buy your stocks at a low price and sell them at a high price. Many investors feel that investing in stocks over a long term is the best way to invest your money. You need to chose good companies with growth potential and sit tight through any bad times. With the advent of computer technology and the Internet more and more investors are buying and selling stocks online. A new wave of investors called “day traders” has arisen. These traders buy and sell in a day. They hope to ride waves in the market and cash in quick. This type of investing is very risky and is not for everyone.
Mutual Funds are large groups of stocks that are bought by large groups of investors. Mutual Funds are the most popular way for people to invest today because they limit risk and provide an acceptable level of reward for a long term investment. Mutual funds are managed by professional fund managers who buy an sell stocks for the fund based upon a basic strategy. There are many different types of funds. There are conservative funds, aggressive funds, Internet funds, balanced funds, index funds and others. Index funds, for example, buy the stocks that are in a stock market index like the Dow Jones and S&P 500. Internet funds buy Internet companies and the like. There are two categories of funds that you can buy in to, load and no load funds. A load fund means you pay commission and a no load fund means you do not pay commission. No load funds pay you slightly lower rate in exchange for their services. Picking the right fund for you takes time and research. The CBS MarketWatch site has excellent info to help you choose a fund.
When an government agency, municipality or institution or company needs to borrow money for long periods of time, it often issues bonds. Bonds are long-term obligations that pay a stated rate of interest for a specified number of years. First of all, bonds have three main components: the coupon (the stated interest on the debt), the maturity (the life of the bond), and the principal (the amount that will be repaid to the lender upon maturity). The principal is usually linked to a dollar value that is called the par value. Another characteristic of bonds is their prices. Investors see bonds as financial assets but take into account the changes in the future interest rates, the risk that the company will default and other factors before deciding on what to offer. The final price is established by supply and demand. Bond yields, the annual interest divided by the purchase price, are used to compare bonds. Bonds are not insured, and there are no guarantees that the issuer will be around in 20 years to redeem the bond. As a result, investors will pay more for bonds issued by an agency with an impeccable credit rating. Investors will pay less for a similar bond if a corporation with a low credit rating issues it. The final characteristic of bonds is bond ratings. Standard & Poor’s and Moody’s are two major corporations that publish bond ratings for the benefit of the investor. They rate bonds on a number of factors, including the financial health of the issuer, the ability to make the future coupon and par value payments, and the issuer’s past credit history. They are rated on a scale, which ranges from AAA, the highest investment grade, to D, for default.
Corporate bonds are an important source of corporate funding. Investors usually decide on the highest level of risk they are willing to accept, and then try to find a bond that has the best current yield. Those that are very risky carry a BB rating on the S&P 500. These bonds carry a high rate of return as compensation for the possibility of default. Investors usually purchase corporate bonds as long-term investments. Sometimes these are known as “junk bonds” is they have a very low credit ratting.
Municipal Bonds are bonds issued by state and local government units to fund different types of public works. They are generally regarded as safe because state and local governments do not go out of business. Because governments have the power to tax, it is presumed that they can pay interest and principal in the future. Municipal bonds are generally tax-exempt. This allows the governmental unites to pay a lower rate of interest on the bonds, thus lowering their cost of borrowing. Government savings bonds are low-denomination, nontransferable bonds issued by the United States government, usually through payroll-savings plans. They are available in denominations ranging from $50 to $10,000 and are purchased at a discount from their redemption amount. The government pays the interest on these bonds, but it builds the interest into the redemption price rather than sending checks to the investors on a regular basis.
Savings bonds are attractive because they are easy to obtain and there is virtually no risk of default. Most investors tend to hold long-term savings bonds. Like the United States, many other nations issue bonds, although they are generally available only in large denominations. Pension funds, insurance companies, and large corporations with large ash reserves purchase these bonds. The risk of international bonds is harder to determine than other types of bonds, so investors have to choose carefully.
International bonds are unique in that they make coupon and principal payments in another currency but the investor doesn’t know how that currency will compare to the dollar in the future.
Treasury Notes (T-Bills)
Treasury notes are US government obligations with maturities of 2 to 10 years, which Treasury bonds have maturities ranging from more than 10 to as many as 30 years. The only collateral that secures both is faith and credit of the US government. Federal government borrowing generates financial assets known as Treasury bills. Treasury bills are short-term obligations with a maturity of 13, 26, or 52 weeks. They do not pay interest directly, but are sold on a discount basis, like government savings bonds.
Individual Retirement Accounts (IRA’s) are long-term, tax-sheltered time deposits than an employee can establish as part of a retirement plan. The worker deducts the deposit from his or her taxable income at the end of the year. Taxes on the interest and principal will eventually have to be paid. IRA’s are not transferable, and penalties exist if they are liquidated early. Lately an IRA called a ROTH IRA has become popular. It allows a parent to invest money tax free for their children and the child can then take out the money later, under certain circumstances.
Coffee, the wheat, oil and dozens more items are called commodities. They are the raw materials of life. They don’t have brand names, they haven’t been turned into anything. They’re just the stuff that dreams, and fortunes, are made of.
And the way those fortunes are made is by people who buy and sell contracts to deliver a set amount of a commodity, say cocoa from West Africa, at a set date for a set price. Those contracts are called futures.
A futures contract is a legally binding obligation for the holder of the contract to buy or sell a particular commodity at a specific price and location at a specific date. They can change value very fast because of changes in the weather, or politics, or people’s expectations about what’s going to happen.
People who trade futures pay a lot of attention to the weather because a lot of commodities are things that grow, such as wheat, oranges, cocoa and cotton. They also pay a lot of attention to politics because things like wars and revolutions can affect the price of oil, and natural gas and gold. Because so many commodities are agricultural products the Commodity Research Bureau Futures Price Index is among the most closely watched indicators of future futures activity.