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Understanding Investment Products

alexsandralyn By alexsandralyn on
Badge: Advisor | Level: 17 | Finances Expertise:

I am my mother's financial advisor, the person she calls whenever she wants me to help her understand her own retirement investments in Wal-mart shopper's English rather than Charles Schwab Stockbrokerese.

What are mutual funds?

Mutual funds are a collection of stocks and bonds that are bought and sold by a mutual fund manager who acts on behalf of the fund's shareholders. Mutual funds are either load, meaning that there's an up front sales charge to buy them but usually a lower annual fee to hold them, or no load, meaning that there's no up front sales charge to buy them, but usually a higher annual fee to hold them. The NAV, or Net Asset Value, of the fund is determined by the current price of the stocks and bonds in its holdings divided by the number of shares outstanding in the fund.

What are stocks?

Stocks are a partial ownership interest in a business. When a business is profitable, the management may share those profits with the shareholders in the form of dividends. Or the management may reinvest the profits to grow the business, in which case, the market value of the shares will go up and they can be sold for capital gains. On the converse, when the business is suffering losses, the shareholders also suffer losses on the market value of their shares.

What are bonds?

Corporate bonds are business loans that are made by private investors to a business for a fixed duration and interest rate. Municipal and Treasury bonds are business loans made by private investors to a local, state or federal government for a fixed duration and interest rate, and are tax-free investments. Bonds can be traded on the secondary bond market if an investor wishes to cash out early. The idea that bonds are safer than stocks is mostly a myth. If a company such as GM goes bankrupt, secured bank loans will get paid first out of the assets of the business, then the corporate bondholders, then the preferred and common stockholders if there's any money left over. But in the case of GM, the bondholders only received $0.30 on the dollar for the value of their bonds, taking a 70% loss on their original investment.

What are annuities?

Annuities are similar to mutual funds in their holdings, however, they're usually issued by insurance companies, they are tax-deferred, and unlike an IRA or 401K, there's no limit to how much money can be invested into an annuity. A fixed annuity guarantees a percentage of income from the investment over a period of time, such as a 6% annual return for 10 years, whereas a variable annuity ties the percentage of income to the market performance of the investment. One particularly noteworthy type of annuity is the "variable annuity with an income rider" that guarantees a minimum percentage of income like a fixed annuity, but should the market perform better that year, the annuity will pay the highest attained value like a variable annuity. A variable annuity with an income rider can be a good choice for people who want the higher returns that can be had in the stock market, but without the risk to their principal or monthly income flow.

What are closed end funds?

Closed end funds are similar to mutual funds, however, they don't issue new shares after their initial public offering, and they are traded like stocks on the stock exchange if you want to buy into a closed end fund. Closed end funds will often sell at a discount or a premium to their net asset value (NAV), and the NAV is determined by the current price of all of the funds holdings on the market. CEF Connect offers a closed end fund screener that will help to identify high yielding dividend funds that are currently selling at a discount to their NAV on the stock exchange.

Investing the in the stock and bond market is a lot like shopping at Wal-mart. You want to buy the stocks and bonds when they're on sale if you can, and you certainly want the best quality that money can buy at the price you can afford. If the stock and bond market is too confusing to you, then hire a good local financial advisor to help you choose the right investment products for your own needs.