Short Term Vehicles
Short term vehicles are investments that usually have lives of one year or less, and they carry little or no risk. Often these types of investments are used to store idle funds and earn a return until the funds are invested in long term vehicles. They are also more popular among conservative investors who may use the short term vehicles as their primary investments. Short term vehicles also provide liquidity, meaning they can be converted into cash quickly with little to no loss in value. Liquidity is an important part of any financial plan.
Common stock is an equity investment that represents ownership in a corporation. Each share of common stock represents a fractional ownership interest in the corporation. For example, if a corporation has 100,000 shares of common stock outstanding, each share would represent 1/100,000 ownership interest. More than half of all U.S. families own some common stock, either directly or indirectly. The returns earned through common stock can come from either of two sources: dividends or capital gains. Dividends are periodic payments that the corporation makes to its shareholders from its earnings. Capital gains comes from selling the stock at a price that is higher than what it was originally purchased for.
Fixed Income Securities
Fixed income securities are investment vehicles that have a fixed periodic return. Some will offer contractually guaranteed returns while others have a specified, but not guaranteed, returns. Due to their fixed returns, fixed income securities are usually popular during times of high interest rates, when investors want to “lock in” high returns.
Bonds-Bonds are long term debt instruments issued by governments and corporations. The bondholder has a contractual right to receive a known interest return, as well as the return of the bond’s face value.
Convertible Securities-A convertible security is a special type of fixed income obligation. It permits the investor to convert it into a specified number of shares of common stock. This type of security provides the fixed income benefit of a bond while also offering the price-appreciation potential of common stock.
Preferred Stock-Preferred stock, like common stock, represents an ownership interest in a corporation. However, preferred stock has a stated dividend rate. Payment of the dividend is given preference over common stock dividends of the same corporation. Investors usually purchase preferred stock for the dividends it pays, but it can also provide capital gains.
A mutual fund is a diversified group of securities that is professionally managed. Investors in the fund own an interest in the fund’s group of securities. Mutual funds issue and repurchase shares of the fund at a price that reflects the value of the portfolio at the time of the transaction. Money market mutual funds are mutual funds that only invest in short term investment vehicles.
Derivative securities derive their value from an underlying security or asset. There are usually high levels of risk associated with this investment because they have uncertain returns or unstable market values. Because of the higher perceived risk, the higher levels of expected returns. The main types of derivative securities are options and futures.
Options-Options are securities that give the investor a chance to sell or buy another security at a specified price over a given time period. Usually investors will purchase options in order to take advantage of an anticipated change in the price of common stock. This is riskier because the investor of an option is not guaranteed a return and could lose the entire amount invested if the option does not become attractive enough to use.
Futures-Futures are legally binding obligations requiring that the seller of the futures contract will make delivery and the buyer of the contract will take delivery of the given asset at some specific date, at a price agreed on at the time the contract is sold. Examples of financial futures are contracts for U.S. Treasury securities, interest rates, and stock indexes. Examples of commodities sold by contract include platinum, cocoa, and soybeans. Trading in futures is a highly specialized and high risk.
Other Popular Investment Vehicles
A couple other types of investments are tangibles and real estate. Tangibles are investment assets, other than real estate that can be seen or touched. Examples are precious metals, gemstones, and collectibles. Real estate can be residential homes, undeveloped land, warehouses, apartment or office buildings, and condominiums. The appeal of real estate investments is the returns in the form of rental income, tax write-offs, and capital gains.