Investing Basics: Bonds, Stocks and Mutual Funds
Saving and investing sound similar and yet they are not. They are, however, both sides of the same coin, and things that everyone needs to do throughout their lives. Understanding the basics of these two concepts will set the stage for achieving financial stability and success.
Saving versus Investing
The main difference between saving and investing lies in the when and where: when you need your money and where you’ll be putting it. Saving is typically considered to be putting money away for short-term or current needs like day-to-day expenses or an emergency fund . Savings are generally liquid, meaning they are easy to access, and putting them in an insured account at a banking institution is usually the best bet.
Bank accounts are very safe, but they don’t earn much interest. Sometimes the interest doesn’t even keep up with the current inflation rate. To make your money grow, you must also invest. Investing generally involves a much longer time horizon, like retirement or a child’s college education fund.
Bonds, stocks and mutual funds are three basic types of investment options. They can earn more than a simple bank account can, but they also carry a greater potential for loss if the market should fluctuate or go down.
Bonds — an IOU to you
Governments, municipalities and companies issue bonds to raise money. The bond is essentially an IOU from the issuer promising to pay an investor interest over the life of the bond plus repay their principal, the amount invested, at a certain due date, known as maturity. This is a way to invest while still guaranteeing the principal. It also can be a way of insuring an income stream since bonds often pay interest twice a year. Some bonds also carry tax advantages.
There are still risks involved, however. While U.S. savings bonds are considered one of the safest investments, bonds issued by individual companies or municipalities may be risky if the issuer runs into financial difficulties.
Stocks — a piece of a company
Stocks are a type of security that allow an investor to own a share, or a piece, of a company. When a company wants to raise money, it will sell shares of its stock. If the company performs well, it may pay its shareholders part of its earnings, called a dividend. Stock owners sometimes also get voting rights at shareholder meetings.
Stocks have a great potential for growth over time. However, they also carry a great deal of risk, as the stock market can fluctuate greatly. If you purchase a share of stock and the price goes down, when you sell it, you will lose money.
Mutual funds — a diversified option
It would be difficult for an individual investor to own many shares of a variety of stocks. It might also be hard to pick which stocks to own. One way to get past this is for an investor to buy a share in a mutual fund, which is a pool of money from many investors. Mutual funds may invest in stocks, bonds or other securities, a combination of these, depending on the portfolio, or a selection of funds.
An investment adviser who picks the stocks and other securities manages some of the funds; other funds, known as index funds, simply try to match the returns of major stock market indices like the S&P 500, which is based on the total market value of the 500 largest public companies in the United States.
Another type of fund is a target date fund. This fund is managed with a specific time horizon in mind. Typically, the time frame relates to retirement dates: the further away from retirement, the more aggressive the fund choices. When retirement is closer, the fund will include less risky securities.
The Thrift Savings Plan is a collection of stock and bond funds. Four of the funds (F, S, C and I) are index funds while the G fund is a government securities investment fund. The last type of fund is a Lifecycle fund, which is a type of target date fund.
Mutual funds are less risky than individual stocks because they are more diversified, meaning they contain a mix of investments. However, they do still carry risk, because the shares can lose value if the underlying companies, or the market, face financial difficulties.
Mutual funds also have expenses and fees that can eat into returns, sometimes costing investors thousands of dollars over a period of ownership. Actively managed funds are more likely to have higher expenses than index funds. Investors can analyze a mutual fund’s expenses by using FINRA’s Fund Analyzer Tool.
Protecting yourself when you invest
While all investments carry a certain amount of risk, savvy investors can protect themselves by following a few good practices.
Before investing, know the signs of fraud. The old adage is true: if something sounds too good to be true, it generally is. Service members are at a higher risk of experiencing affinity fraud, a type of scam that targets specific communities or groups.
Make sure you run a background check on any investment professionals before you work with them.
Finally, the best way to make sure you are on the right track with your investing goals is to make an appointment with an accredited personal financial manager or personal financial counselor at your nearest Family Center.
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