Achieving your financial goals takes planning and discipline, but most goals won't become realities unless you start investing your money. Looking at the historical performance of the markets shows you that just keeping your money in savings won't even beat in inflation.
A fundamental understanding of the three basic asset classes-stocks, bonds and cash equivalents-will help you make more informative investment decisions.
Stocks are also referred to as equities, as a share of stock
represents equity in a company. Historically, equities have
outperformed all other asset classes but past performance
does not guarantee future results. Stocks offer the best growth
opportunity over the long-term as well as the highest risk
because their value may fluctuate significantly. Be sure to
assess your risk tolerance before investing in the stock market.
Different types of stocks include:
- Growth and income: Stocks that strive for steady appreciation as well as pay their investors quarterly dividends.
- Large capitalization: Stocks with a very large market capitalization (number of shares outstanding times the price of the shares), typically at least $5 billion.
- Mid capitalization: Stocks that typically have a $1-$5 million market capitalization.
- Small capitalization: Stocks that usually have a market capitalization of $500 million or less.
- Preferred: A class of stock that pays dividends at a specified rate.
Bonds, or fixed-income securities, are considered debt investments because they represent a loan made to a government or corporation for a fixed rate of interest over a specific amount of time. A bond's term may range from several months to 30 years or more and the longer the term, the higher the rate of interest. Bonds are graded based on the credit worthiness of the corporation or government issuing them.
Different types of bonds include:
- Government: Secured by the full faith and credit of the U.S. Government and considered quite safe.
- Corporate: Issued by publicly traded companies.
- Municipal: Issued by states and local governments, the income earned is exempt from federal taxes and in some states, exempt from state taxes.
- High-yield: Also referred to as "junk bonds" as they are speculative, high-risk, high-interest rate corporate or municipal bonds.
Cash equivalents are safe, short-term, very liquid investments that are, as the name suggests, equivalents to cash.
Cash equivalents include:
- Money market funds: Technically a mutual fund, money market funds maintain a share price of $1 with an interest rate that fluctuates.
- Certificates of deposit (CDs): Also referred to as time accounts, CDs provide a "locked" amount of interest for a specific amount of time.