When the interest you can make from simple savings accounts and bank CDs is no longer enough to meet your financial objectives, it is time to take the dive into the world of investments. Stock market novices and seasoned investors alike can run into trouble navigating their way through all the varied investment options available. The best way to make investment decisions is first to understand how the investment vehicles work.
Purchasing stock shares is a way to gain ownership, no matter how small, into publically traded companies. Each quarter, the company reviews its earnings and determines what, if any, earnings to disburse to the shareholders in the form of dividends. How much you make in dividends depends on how many shares you own. For example, a 43-cent dividend to someone with 1,000 shares would equate to $430.
Shareholders may also sell their stock on the market to investors wishing to purchase. If they sell their stock for more than they paid, they make a profit. If not, they sell for a loss.
Bonds are instruments of debt companies of issue when they need to raise funds. Investors purchase them for their issue price and draw a set rate of interest until the bond matures. At maturity, you get back your original investment. In addition to companies, federal, state and local governments also issue bonds to raise money.
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Series EE bonds issued by the United States government are purchased for half of their face value and redeemed for full face value at maturity. No semi-annual or annual interest payments are made with these bonds, as the accrued interest is what makes the bond double in value over the years.
Mutual funds are like a sample platter of stocks or bonds. Rather than having to stay on top of all the intricate financial workings of the company behind your stock, a fund manager does all the research for you and buys or sells stocks in the mutual fund according to the fund's objective. For instance, a stable value fund would include stocks not known for volatility while an income fund might look for stocks and bonds to provide regular dividend and interest payments.
Regardless of which option you choose, always read the prospectus provided. This lengthy legal document contains important information about the stock or mutual fund offering. Also, make sure you feel comfortable with the investment advisor or broker selling you the investment products. If you have a bad feeling about working with him, don't.
Historically speaking, stocks yield higher returns than bonds so they are best suited for investors with long time horizons looking for maximum portfolio growth. Bonds, known for being the more stable investment option during down, or bear, markets, are appropriate for those who are closer to retirement or seeking income. Of course, diversification is the key to a prosperous investment portfolio. Mutual funds were created for this purpose, allowing you a full range of diversity between stocks, bonds and cash holdings without the hefty price it would cost you to buy into each product on its own.
Stocks, bonds and mutual funds are long-term investment options, not get-rich-quick schemes. Making an investment with a short time horizon for needing the funds back is a recipe for disaster. Market fluctuations take time to overcome, just as the commission or fee you pay to acquire them will take to recoup.