As you may have noticed, there are several categories of investments, and many of those categories have thousands of choices within them. So finding the right ones for you isn’t a trivial matter.
The single greatest factor, by far, in growing your long-term wealth is the rate of return you get on your investment. There are times, though, when you may need to park your money someplace for a short time, even though you won’t get very good returns. Here is a summary of the most common short-term savings vehicles:
Savings account: Often the first banking product people use, savings accounts earn a small amount in interest, so they’re a little better than that dusty piggy bank on the dresser.
Money market funds: These are a specialized type of mutual fund that invest in extremely short-term bonds. Money market funds usually pay better interest rates than a conventional savings account does, but you’ll earn less than what you could get in certificates of deposit.
Certificate of deposit (CD): This is a specialized deposit you make at a bank or other financial institution. The interest rate on CDs is usually about the same as that of short- or intermediate-term bonds, depending on the duration of the CD. Interest is paid at regular intervals until the CD matures, at which point you get the money you originally deposited plus the accumulated interest payments.
Long-term investing vehicles:
Bonds: Bonds come in various forms. They’re known as “fixed-income” securities because the amount of income the bond generates each year is “fixed,” or set, when the bond is sold. From an investor’s point of view, bonds are similar to CDs, except that the government or corporations issue them, instead of banks.
Stocks: Stocks are a way for individuals to own parts of businesses. A share of stock represents a proportional share of ownership in a company. As the value of the company changes, the value of the share in that company rises and falls.
Mutual funds: Mutual funds are a way for investors to pool their money to buy stocks, bonds, or anything else the fund manager decides is worthwhile. Instead of managing your money yourself, you turn over the responsibility of managing that money to a professional. Unfortunately, the vast majority of such “professionals” tend to underperform the market indexes.
Investing in stocks:
It’s worth taking a closer look at stocks, because historically, they’ve had much better returns than bonds and other investments.
Essentially, stock lets you own a part of a business. Dating back to the Dutch mutual stock corporations of the 16th century, the modern stock market exists as a way for entrepreneurs to finance businesses using money collected from investors. In return for ponying up the dough to finance the company, the investor becomes a part-owner of the company. That ownership is represented by stock — specialized financial
“securities,” or financial instruments — that are “secured” by a claim on the assets and profits of a company.
Common stock is aptly named — it’s the most common form of stock an investor will encounter. This is an ideal investment vehicle for individuals, because anyone can take part; there are absolutely no restrictions on who can purchase common stock — the young, the old, the savvy, the reckless.
Common stock is more than just a piece of paper; it represents a proportional share of ownership in a company — a stake in a real, living, breathing business. By owning stock — the most amazing wealth-creation vehicle ever conceived (except for inheriting money from a relative you’ve never heard of) — you are a part-owner of a business.
Shareholders “own” a part of the assets of the company and part of the stream of cash those assets generate. As the company acquires more assets and the stream of cash it generates gets larger, the value of the business increases. This increase in the value of the business is what drives up the value of the stock in that business.
Because they own a part of the business, shareholders get a vote to elect the board of directors. The board is a group of individuals who oversee major decisions the company makes. Boards decide whether a company will invest in itself, buy other companies, pay a dividend, or repurchase stock. Top company management will give some advice, but the board makes the final decision. The board even has the power to hire and fire those managers.
As with most things in life, the potential reward from owning stock in a growing business has some possible pitfalls. Shareholders also get a full share of the risk inherent in operating the business. If things go bad, their shares of stock may decrease in value. They could even end up being worthless if the company goes bankrupt.
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