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What Should You Invest In?

October 19, 2002

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.

Retirement plans

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.

Common stock

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.

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