If you’re just beginning to check out the stock market to begin a “career” in investing and trading, then read on. To facilitate the learning process, let’s take a look at the different investment products that are available for trades.
Investment Product Classifications
We’ve already learned what a stock is: ownership in a publicly traded company. But stocks come in several flavors. Let’s take a look at some of the different types of stock available for purchase.
1. Common stock: Common stock is like plain vanilla when it comes to the available types of stock on the market today. Most of the stock issued today is of this variety. Owning common stock gives the stockholder certain rights when it comes to governing the issuing company like voting for management changes and making certain policy decisions. The number of votes you have and therefore the amount of influence you have as a stockholder is directly tied to the number of shares of common stock you own. Common shareholders may be entitled to dividend payments based on decisions made by the company.
2. Preferred stock: Preferred stock is a little more exotic than common stock in this way: preferred stockholders generally have no voting rights; however they generally profit more based on the fact that dividend payments are somewhat more structured than common stock. This means that preferred stockholders tend to have the pleasure of earning a static dividend payment whether the company does well or tanks. The dividend payment does not fluctuate with the financial well being of the company. Preferred stock is issued separately from common stock and at a different price. The company has the right to suspend issuing preferred stock at any time.
So what’s the main benefit of being a shareholder that holds preferred stock? Well they have a “preferred” status when it comes to the bankruptcy of a company. This just means that these guys get paid before the common shareholders do, when the company gets liquidated. Still, having this status is in no way a guarantee of payment if the company goes bust.
Options are another type of investment product. Options are basically contracts that allow the buyer to purchase a stock, a product, or a financial instrument that underlies the option. This one’s a little bit confusing, so let’s take another look at it.
In my company, as part of our annual compensation plan, we receive stock options. In essence, I get a piece of paper that tells me the number of common stocks I can purchase and at what purchase price I can buy them at. When those options mature, usually in seven years, I can “exercise” my options with my broker. This means that I am buying the shares of stock at the “buy” price listed in my contract and selling them at the current stock price, netting the difference (minus the broker’s commission, of course). The broker sends me a check and my options are now gone.
This works the same way with other underlying instruments. The option contract lists the number of shares of whatever that can be bought and what the “buy” price is. After the options mature, the holder can choose to hold on to them and wait for a good price or sell them and net the profit, if there is one. This is probably a really good time to mention that there are no guarantees in the market and that even though options’ “buy” prices are usually under the current trading price, there is a very real possibility that the value of the underlying instrument will decrease to the point that exercising your options may actually cost you money.
Like stocks, there are a few different types of mutual funds available for you to invest in. Let’s take a quick peek:
1. Equity Funds: An equity fund is simply a portfolio of stocks that is created based on risk and asset class. A mutual fund has a fund manager that picks stocks based on his or her personal knowledge and expertise in any given area. The fund is then assembled based upon the amount of risk they represent to the individual investor. The more aggressive a fund is, the more risk there is such that the investor can lose part or all of the money that he or she has invested into the fund.
2. Bond Funds: Like an equity fund, a bond funds is a portfolio; it’s a portfolio of bonds. Unlike with buying bonds outright, an investor will find that a bond fund lacks a specified maturity date or fixed interest rate. The nice thing about bond funds is that you have more freedom when it comes to redistributing your money due to the lack of a finite maturity date. Like equity funds, bond fund portfolios are structured based on the risk profile of the investor. Less risky bond funds invest in corporate bonds while riskier endeavors toy with junk bond funds in an effort to elicit a higher return.
3. Money Market Funds: Money market funds work exactly like equity funds and bond funds except the portfolios are created from cash equivalents. The main goal of a money market fund is to maintain a $1 per share price. Instead of long term growth, money market funds offer “interest” gains and are not designed to be a long term investment strategy, but more like a high interest cash or savings account or bank certificate of deposit. The main drawback to this type of investment is that money market funds are not FDIC insured, so a highly cautious investor may be more comfortable with other forms of savings (although the interest rate for FDIC insured instruments may not be as good).
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