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The Basics of Investments

By Judy Loy
Registered Investment Advisor, ChFC®, RICP® and CEO of Nestlerode & Loy, Inc.

With the disappearance of pensions, people are becoming more dependent on their investments for their retirement. Understanding the basics for investing your 401k, SIMPLE IRA or Roth IRA is important. I am going to review some basics but not all investments are right for everyone.

First, the investment we hear the most about are stocks. Stocks are shares in companies and give stockholders a share of ownership in that company. Often, stocks are also called equities. 

Common stocks entitle owners to vote at shareholder meetings and offer potential for growth, which is also called capital appreciation. In layman’s terms, this means the price of your shares may go up and you will have an unrealized capital gain. If it is unrealized, it is not taxed. Once you sell your shares and take the profit, the gain becomes realized and unless it is inside a tax-deferred vehicle (IRA, 401k, etc,), capital gains tax (short term=held less than a year or long-term=holding one year or more) is owed on the gain. The opposite is true; the stock may go down in price, which means you may take a loss. You can lose money investing in stocks as they are not guaranteed. 

Stocks may also pay dividends. Dividends are a sum of money paid regularly (typically quarterly) to a company’s shareholders out of its profits or reserves. Therefore, with dividend paying stocks, you may be looking for both growth (capital appreciation) and income (dividends). This mostly describes common stock and if a company goes bankrupt, common stockholders are last in line when assets are liquidated. 

Another type of stock that resembles fixed income (coming up next) is preferred stock. Preferred shareholders usually don’t have voting rights but they receive dividend payments before common stockholders do, and have priority over common stock if the company goes bankrupt. They are usually less volatile than common stock and bought for their dividends. 

Fixed Income is sometimes used interchangeably with bonds. Fixed income pays out level cash flows to investors, typically in the form of interest. Bonds are mostly issued by governments and corporations. Bonds have a coupon rate, face value and maturity.  Think of it as the opposite of your mortgage. You let a company borrow your money, say $10,000, to finance their business plans. In return, they promise to give you back your $10,000 in 20 years. While they borrow your money, you earn an interest rate that they promise to pay you annually. The coupon rate is based on the face value so a bond that has a 5% coupon rate and a face value of $10,000 would pay the lender (you) $500 each year until they give you your money back. The ability to pay that amount to you (the lender) each year in interest and return your $10,000 is dependent on the financial ability of the borrower.  

The bond’s credit rating is their ability (assigned by a rating agency — Moody’s, S&P Global and Fitch Group) to make those payments. Investment-grade bonds are those that are believed to be lower risk of default and have creditworthiness. High-yield bonds, formerly known as junk bonds, are considered high risk and are issued with higher yields than investment grade to compensate for the risk. Bonds are paid ahead of stockholders in a company’s bankruptcy, so they are typically less volatile than stocks.

These are really the basics of these securities. Interest rate risk, value, growth and municipals are all further delineations and important information on these securities. Discuss what options are best for you according to your risk, timeframe and needs with a professional. In my next article, we will look at investments that consist of these securities, mutual funds and exchange-traded funds (ETFs). These are the types of securities most common in retirement plans so their basics are important when allocating your plan assets.

All investing is subject to risk, including possible loss of the money you invest. Nothing in this article should be construed as investment or retirement advice.  Always consult with a professional advisor and consider your risk tolerance and time to invest when making investment decisions.