Published by Dan Morrison
Ok, kids. Time for a refresher on the basics of investing. It seems these days people are always wanting to make the process of investing sound sexy and complicated. Mostly, I guess, to impress their friends. “My broker has me in a triple-times, hedged, long/short, tax-efficient stretch lion with a one and a half twisting backflip.” Ok, I made that up. But, you get my point.
In reality, any type of investment you can think of – stocks, bonds, CDs, precious metals, etc. – all boil down to this: safety, income or growth. Each investment will do one of these three things well and maybe a second one to a lesser degree. But, NO investment will give you all three.
Let’s look at a couple of simple examples, starting with Certificates of Deposit (CDs) at the bank. Which of the three do you think CDs provide, first and foremost? Go ahead, guess. Go ask someone if you need, I’ll wait… Safety. Correct! CDs give you safety on your principal because the FDIC backs them (up to $100,000). What about income? Yes, a CD will pay you some income. What about growth? No, a CD will not grow (appreciate) in value. The account may go up if you reinvest the interest, but that’s not true growth. So, CDs provide safety first, with secondary income and no growth.
What about bonds? A bond is a loan made to an entity (typically a government or company). For example, you may agree to loan General Motors $10,000 for 10 years at 6% interest. Over the next 10 years, they will pay you 6% ($600) a year, and at the end of the 10 years, they will give you your $10,000 back. Based on this information, what is the primary purpose of a bond? Bonds produce income; money you can spend today. Do bonds provide safety? Well, some. They are often backed by the assets of the company or revenue of the government to whom you’ve lent the money. And growth? No. Again, like CDs, bonds don’t appreciate in value. At the end of the term, you only get your principal back.
Finally, let’s look at stocks, or equities as they are also referred. A stock represents ownership in a company. Buy one share of Apple and congratulations, you can tell all your friends you own Apple. Now, Tim Cook may not be calling you for advice anytime soon, but you are technically an owner. If Apple does well, and more people want to buy their stock, the price may go up. And you, as an owner of shares, will benefit from that. Your shares will appreciate in value! They will grow! Stocks, then, provide growth as their primary benefit. How about income? Again, some companies pay a dividend, which is a way to return profits to stockholders. Thus, there may be some income. And safety? Nope. No safety. If the company you buy stock in does poorly, your value can depreciate, sometimes all the way to zero. So, stocks are where you go for growth and some income, but not for safety.
The question you should be asking your advisor is, “Do my investments line up with what I need my money to do for me?” Likewise, you may want to review how your investments are blended together to give you the right benefits (safety, income and growth) in the right balance for you and your goals.
For more information on investing, check out our free guide on the True Cost of Investing by clicking here.