Basics

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Station 2 - Selecting investments:
Stocks Bonds || Real estate || Precious metals || Foreign investments || Selecting a broker || Commodities || Antiques & collectables || IRAs || Mutual funds

Once you decide to take the plunge and begin investing, the next question you must anwer is: In what should I invest? There are so many investment options -- stocks, bonds, real estate, precious metals, commodities, antiques and collectibles, etc. -- that many people quickly become bewildered. It is possible to invest in any and all of these areas. And you may want to consider foreign investing as a entire new layer to your personal investing landscape.

One of the first investing decisions you will need to make is which broker and/or brokerage firm to use. A broker is a person who mediates between you (as the buyer or seller of a security) and the other party.

A brokerage firm is a company that specializes in this type of brokering. Financial planners also can be useful allies as you pursue your investment goals. Full-service brokerage firms offer personalized attention to you and the progress of your investment portfolio. Discount brokerage firms offer much less personal attention, but they are also much less expensive than full-service brokerages.

Don't hesitate to ask family members, friends, and colleagues about their experiences with brokers and brokerage firms. Not only will you hear the names of some good brokers (and probably some bad ones, too), but you'll also begin to better understand the nature of the broker/client relationship. There also are great online resources to help you select a broker, such as the bullet points on the SEC website (http://www.sec.gov/investor/pubs/inws.htm).

When selecting a broker, obtain and read all the information you can about that particular broker and, if appropriate, the brokerage firm for which he or she works. You may want to investigate several brokers before selecting one to work with. Schedule appointments and try to meet face-to-face. You will need to feel comfortable with and trust your broker. You will want to feel comfortable with her or his knowledge, experience, communication style, overall personality, suite of available services, and, of course, price structure. Also, be prepared to discuss your overall financial and investing goals with your broker. Your broker will want to learn as much about you. If your broker works for a brokerage firm, you will want to learn more about that firm, too. The FINRA website (http://www.finra.org/InvestorInformation/InvestorProtection/p005882) provides a free online tool to help you check the professional backgrounds of securities firms and individual brokers.

Many individual investors are opting to use online brokerage firms. When investigating online brokerage firms, you will want to note how much money you must deposit to open an account, the mix of securities (mutual funds, foreign stocks, bonds, penny stocks, IPOs (initial public offerings), etc.) each online brokerage firm offers, the available and costs of phone support, and other financial and research services offered by the online brokerage firm.

A stock is an indication that you possess partial ownership in a corporation. All of the stockholders as a group form the owners of a given corporation. Types of stocks include common and preferred stocks.

A common stock usually empowers the stockholder to vote at meetings of the shareholders and to receive dividends, whcih are distributions of a portion of a company's earnings to its shareholders. Holders of preferred stocks often have no voting rights, but they may have a higher or prior claim on the assets and earnings of the company, especially if the company goes bankrupt or is liquidated.

Stocks, of course, are bought, sold, and traded on stock markets, such as the New York Stock Exchange, Nasdaq, the London Stock Exchange, and other stock exchanges around the globe. Historically, stocks as a whole have outperformed other types of investments, such as bonds or savings accounts.

Most individual investors purchase and sell stocks through brokers and brokerage firms. However, sometimes it is possible to purchase stock directly from the company. Dividend Reinvestment Plans (DRIPs) and Direct Investment Plans (DIPs) are methods used by some companies to allow individuals to invest in the company's stock, often at regular intervals over a period of time.

A bond is a long-term promissory notes in which the issuer (a government, for example) agrees to pay you the amount of the face value of the bond on some future date, as well as pay a specified interest rate at regular intervals. Bonds basically are a form of debt undertaken by corporate and governmental entities to raise money for projects, new ventures, etc. Bonds generally involve lower risk than stocks, but they also generally pay a lower rate of return.

The primary issuers of bonds in the U.S. are corporations, municipalities, and the U.S. Treasury. Each issuing entity of bonds has a certain quality of its credit, which, along with the duration of the bond, helps to determine the bond's interest rate. The maturity periods for bonds range from 90 days to 30 years, depending on the type of the bond and the issuing entity.

Bonds often are graded by private independent rating services, such as Standard & Poor's and Moody's. The ratings, which range on the S&P scale from AAA as the highest to C for junk bonds, are based on an analysis of the financial strength of the issuing governmental or corporate entity.

Investing in the bond market may also have some positive tax implications for individual investors. Many "municipal bonds" sold by states, counties, and cities are tax-exempt at the federal level, and often at the state and local levels, too, if the individual investor lives in the state and/or city in which the municipal bonds were issued.

A mutual fund is a pool of money invested by an investment company in a number of investment areas, such as stocks, bonds, and government securities. Each mutual fund has its own mix of investments. Because most mutual funds invest in a wide range of areas, they can offer investors the benefits of a diversified portfolio, which may include reduced risk.

Mutual fund companies are classified by the Securities and Exchange Commission (SEC) as "open-end investment companies" which means that on a daily (or more frequent) basis, the company is issuing new shares to investors and buying back shares from investors who have decided to leave the mutual fund.

Mutual funds began in the 1920s, but they really grew in both numbers and combined assets in the Sixties, Seventies, and Eighties. Today there are over 8,000 mutual funds in the U.S., with combined assets of over $12 trillion.

There are many different types of mutual funds. Some invest primarily or exclusively in U.S. securities, some are a mix of U.S. and foreign securities, and some are primarily or exclusively comprised of foreign securities. Equity funds are the most common type of mutual fund, accounting for approximately 50 percent of the industry.

Exchange-traded funds (ETFs) are generally index funds that track stock market indexes. Mutual funds are managed by management companies, which hire (and fire) fund managers to develop, monitor, and modify the portofolio of investments in concert with the stated objectives of the mutual fund. The "net asset value" (NAV) of a mutual fund is the current market value of the securities within the fund, minus any liabilities the fund may be carrying. The "public offering price" (POP) of the mutual fund usually is the sum of the NAV and a sales charge.

Mutual funds often are grouped based on the size of their capitalization ("cap"): micro-cap, small-cap, mid-cap, and large-cap.

Individual Retirement Accounts (IRAs) are tax-deferred financial plans that individuals establish with one or more financial institutions, such as banks, mutual funds, or brokerage firms. Individual investors often make periodic (usually annual) contributions to their IRAs. The Internal Revenue Service has many rules and requirements for putting money into an IRA and taking money out. See, for example, IRS Publication 590 (http://www.irs.gov/pub/irs-pdf/p590.pdf). Generally, if you take money out of an IRA before you reach the retirement age of 59 1/2 years, you will be required to pay penalties.

Contributions to a traditional IRA are held by a designated institution, such as a bank or brokerage firm, and may be invested by that designated institution. The main advantage of a traditional IRA is that the contributions you make to it over the years usually are tax-deductible. However, when upon retiring you begin to withdraw funds from your IRA, those withdrawals probably will be taxed by the federal government at rates applicable at the time of withdrawal.

The Roth IRA investment vehicle, established in 1998, allows an individual investor to invest in a wide variety of securities and then manage the Roth IRA in various flexible ways. Compared to a traditional IRA, the Roth IRA's contributions are not tax-deductible, but usually withdrawals are tax-free. In most instances, it is possible to convert a traditional IRA to a Roth IRA, but there are exceptions, and there may or may not be strategic investment advantages in doing so.

The U.S. economy is large, but it still represents only a fraction of the total world economy. Investment advisors often argue that it makes little sense to limit one's personal investing only to companies that operate primarily or exclusively in the U.S. They argue that foreign investments not only allow you to select from a lareger pool of companies and sectors in the global economy, thus further diversifying your personal investment portfolio, but also because foreign investments can offer some opportunities for high returns on investments.

Many personal investors are actively pursuing foreign investments. In 2006, for example, over half of the new money flowing into U.S. mutual funds was earmarked for foreign investments. Investing globally carries some seemingly inherently hightened risks. When you invest abroad, you may lose the consistency of a single currency, standard accounting practices, securities trading laws and rules, reliable information, and watchdog organizations. Although not unknown in the U.S., political unrest and governmental instability abroad can lead to increased investment risks.

Many mutual funds are available that include some foreign investments. Global funds generally focus on promising investments anywhwere in the world, including the U.S. Foreign funds, on the other hand, invest almost all their assets outside the U.S. If you are trying to geographically diversify your portfolio and want to make sure you have invested in foreign companies, a foreign mutual fund may be the path to follow.

Regional funds and emerging market funds also are available. They focus their investments on specific countries, regions of the world, or small (usually volatile) markets. These funds tend to involve significant risk, often with breathtaking climbs and dips. Currency conversions add another wrinkle to foreign investments. As the U.S. dollar rises and falls against other world currencies, that may affect how well your foreign investments perform for U.S. citizens. The effects of continued globalization need to be considered too. Some financial analysts note that increasing globalization of many economies and investment markets has resulted in a world economy in which many of the components are more "in synch" with each other than they were, say, 25 years ago. For an individual investor trying to diversify his or her investment portfolio, this may mean that foreign investments now pack a softer diversification punch.

Real estate includes land and/or buildings. Of course, the home you reside in is an investment, but you also can build a portfolio of non-owner-occupied real estate, including other residential and commercial property, vacation homes, and undeveloped land. Investment real estate holdings usually generate income through a combination of rent and price appreciation in the real estate market.

As with most types of personal investing options, there are tax implications associated with investment real estate. Some of the tax advantages of the real estate you use as your primary residence may not pertain to investment real estate.

When considering real estate investments, two key concepts to consider are equity and liquidity. Home equity, for example, is the dollar value of the owner's share of the value of a property, after the balance on the mortgage and other outstanding debts have been subtracted. For example, if you own a home with a current fair-market value of $200,000, and the remaining balance on your mortgage for that home is $100,000, you have $100,000 in equity in that piece of real estate.

Real estate investments are notoriously low in liquidity. Liquity is the ability to convert one type of investment (e.g., real estate) into another type (e.g., cash) quickly with minimal loss of value in the initial investment. On a smaller scale, using a pawn broker provides a rough lesson in liquidity. That piece of jewelry you purchased last month for $1,000 may bring only $100 from a pawn broker. Real estate and collectables usually have low liquidity and may serve you better as long-term investment strategies, perhaps spilling over multiple generations.

The value of almost any piece of real estate is affected not only by the size, quality, and condition of the piece of real estate itself, but also about the surrounding pieces of real estate. A four-bedroom, three-bath home in a run-down neighborhood across the street from a fast food restaurant probably will have a lower market value than the same home situated in a well-maintained neighborhood.

Real estate investment trusts (REITs) are available for personal investors. A REIT is a type of security that is bought and sold like stocks on the major exchanges. A REIT invests in real estate either directly through properties (also known as an Equity REIT) or indirectly through real estate mortgages--Mortgage REITs. There also are Hybrid REITs that -- you guessed it -- invest in both properties and mortgages. REITs tend to focus on larger real estate holdings, such as shopping malls, business parks, apartment complexes, entertainment complexes, warehouses, motels, and resorts. Some REITs focus on a specific type of real estate, and others focus on a specific geographic area, such as a state, region of the nation, or country.

A commodity is something with a defined uniform value that is produced by many suppliers and traded on one or more commodity markets. Commodities include agricultural staples (corn, soybeans, coffee, cotton, sugar, etc.), livestock (feeder cattle, hogs, pork bellies, etc.), precious metals, industrial metals, energy sources (crude oil, natural gas, etc.), and other things.

Commodities generally are traded on exchanges, such as the Chicago Board of Trade, the New York Mercantile Exchange, and London Metal Exhange. Commodities often are traded as "futures" or futures contracts. Individual investors should note that they are entering into contracts, not purchasing equity in a corporation or piece of real estate. This means that investors are not actually purchasing specified amounts of a commodity, but rather futures contracts to buy specific quantities of a given commodity at a specified price with actual delivery set for a specified time and date. The investors do their work before the actual date the commodity is to be delivered, usually to some processing plant or manufacturer.

Commodity trading also can involve what are known as options. An option contract is an instrument that gives the owner the right to buy or sell a specified amount of a specified commodity within a specified period of time.

Grading and quality control are essential to any commodities market. Government agencies, such as the U.S. Dept. of Agricuture, play a role in defining and verifying the grade and quality of various commodities. In the U.S., the trading of commodity futures is regulated by the Commodity Futures Trading Commission, a federal agency.

Although commodities trading began with agricutural products (e.g., rice in Japan and hard spring wheat in Minneapolis), financial products also are traded now in a commodity fashion.

Precious metals include both well-known metals such as gold and silver as well as lesser known precious metals such as palladium. Some individual investors choose to diversity their investment portfolios by actualling purchasing and holding some previous metals, often in the form of coins or jewelry, in safety deposit boxes. Gold, for example, is considered a form of timeless, international currency. Nearly all societies and cultures across the ages have placed a high value on objects made of gold.

In a time of economic collapse and/or social/political upheaval, gold may be accepted and exchanged for needed goods and services when other securities such as stocks, bonds, and national currencies may have lost most or all of their market value. Investing in some precious metals to hold, therefore, can be understood as a coping strategy for catastrophic times.

Collecting collectibles can be a hobby, a form of personal investing, or both. As an individual investor interested in collectibles, you need to decide what role collectibles will play in your life as well as in your investment portfolio. Beware: Sometimes your affection for your collectibles as an avocational interest can cloud your judgement of those same collectibles as an investment.

Collectibles are basically anything that people collect. The range of collectibles is almost limitless -- baseball cards, toys, figurines, you name it. Antiques can be loosly defined as collectibles that are old and exhibit some sort of craftsmanship. The public television show "Antiques Roadshow" and the online trading venue eBay have done much to increase the awareness of and enthusiasm for collectibles.

To be good at collecting a certain type of thing, you need to develop a certain level of knowledge and expertise about that type of object. Most people take a long-term interest in collectibles Investing in collectibles contains its own set of risks. The seller of an object may misrepresent the nature or condition of an object for sale. The object may be lost, damaged, destroyed, or stolen. The tastes and wisdom of the crowd involved in a collectible area may evolve significantly over time.

Collectibles can be bought, sold, and traded at flea markets, antigue malls, conventions, auctions, garage sales, and online. Investing in collectibles generally offers low liquidity (that is, they cannot be quickly and easily turned into cash), and they do not provide many tax advantages.

Collectibles usually generate cash only at the time they are sold, with no periodic income via dividends. They appreciate in value over time based on the overall demand for those items, their rarity, and other factors. The value of some collectible items can be based on popular trends, and they peak in value as a collectible rather quickly. Other types of collectibles tend to appreciate in value rather steadily over a longer period of time, such as decades and even centuries. Collectibles often are held by the individual investors, which can create storage needs, insurance needs, and safe shipping needs.