Investment Products: Your Choices

You're at that stage in your financial journey when you need to make decisions about the investment products that are right for you. Here are some of your major choices:

How Stocks and Bonds Work 

Many companies offer investors the opportunity to buy either stocks or bonds.

Let's say you believe that a company that makes automobiles may be a good investment. Everyone you know is buying one of their cars. Plus your friends report that the company's cars rarely breakdown and run well for years. You either have an investment professional investigate the company and read as much as possible about it, or you do it yourself. After your research, you're convinced it's a solid company that will sell many more cars in the years ahead.

The automobile company offers both stocks and bonds. With the bonds, the company agrees to pay you back your money, your initial investment in ten years, plus pay you interest twice a year at the rate of 8% a year.

If you buy the stock, you take on the risk of potentially losing a portion or all of your initial investment if the company does poorly. But you also may see the stock increase in value beyond what you could earn from the bonds. If you buy the stock, you become an "owner" of the company. You'll only make money if the company does well and other investors think so too.

Because it is sometimes hard for investors to become experts on various businesses—what are the best steel, automobile, or telephone companies—investors often depend on professionals who are trained to investigate and recommend companies that are likely to succeed. Since it takes work to pick the stocks or bonds of the companies that have the best chance to do well in the future, many investors choose to invest in mutual funds.

Considering Mutual Funds 

After investigating the prospects of many companies, one or more investment professionals pick the stocks or bonds of companies and put them into a fund. Investors can buy a share of the fund, and their share rises or falls in value as the values of the stocks and bonds in the fund rise and fall. Investors may pay a fee when they buy or sell their shares in the fund, and those fees in part pay the salaries and expenses of the professionals who manage the fund while they own shares.

Even small fees can add up, so you need to look carefully at how much a fund costs and think about how much it will cost you over the amount of time you plan to own its shares. If two funds are similar in every way except one charges a higher fee than the other, you'll make more money choosing the fund with the lower cost.

Mutual funds appeal to many investors because:

• You can often invest with a small amount of money.

• Some mutual funds spread their investments over a large number of companies so your investment is diversified. (You haven't put all your eggs in one basket.) If you have a small amount of money to invest, investing in mutual funds may be the only way you can diversify your investments.

• The professionals who run the fund choose the investments and monitor them continuously.

Understanding the Ups and Downs of Investing

You can make money in an investment if:

• The company performs better than its competitors.

• Other investors recognize it's a good company. So that when it comes time to sell your investment, others want to buy it.

• The company makes profits, meaning they make enough money to pay you interest for your bond, or maybe dividends on your stock.

• The people who run the business are honest, hardworking, and talented.

You can lose money if:

• Their competitors are better than they are.

• Consumers don't want to buy the company's products.

• They fail at managing the business well, they spend too much money and their expenses are larger than their profits.

• Other investors that you would need to sell to, think the company's stock is too expensive given its performance and future outlook.

• The people running the company are dishonest. They use your money to buy homes, clothes, and vacations, instead of using your money on the business.

• They lie about any aspect of the business: claim past or future profits that do not exist, claim it has contracts to sell its products when it doesn't, or make up fake numbers on their finances to dupe investors.

• The brokers who sell the company's stock manipulate the price so that it doesn't reflect the true value of the company. After they pump up the price, these brokers dump the stock, the price falls, and investors lose their money.

• You have to sell your investment when the market is down.