Understanding these classifications is the first step in choosing a financial program that’s best-suited for your needs.
What Are Stocks?
Stocks (also known as equities) represent a share of ownership in a corporation. Shares of stock are offered for sale by companies as a means of raising money and providing investors an opportunity to participate in the overall performance of the company. The value of a share of stock may fluctuate more than that of bonds or cash equivalents, which are usually less risky. Long term, however, stocks as an asset class have generally produced a higher return than either bonds or cash equivalents. Of course, past performance is no guarantee of future results, and performance varies among individual stocks.
What Are Bonds?
Bonds are issued by a company or government entity as a way to borrow money and represent loans made by the bondholder to the company or government entity that issues them. A company may issue bonds because it needs funds to expand its business, while a government entity may issue bonds to build or improve roads. Bonds are generally expected to provide an investor with a fixed rate of interest and to re-pay the principle amount of the investment on a stated future date (at maturity). Bonds are generally considered to be less risky than stocks but more risky than cash equivalents.
What Are Cash Equivalents?
Cash equivalents are “liquid” assets – assets that can easily be turned into cash. They include treasury bills, bank certificates of deposit (CDs), commercial paper (the short-term IOUs of large U.S. corporations) and money market funds. Cash equivalents carry less risk in terms of volatility but have historically produced lower returns than stocks and bonds.
What About Mutual Funds?
Mutual funds are not another category of assets. They’re investment vehicles that pool assets from many people to invest in one or more of the three general investment categories described above. By pooling assets from many investors, a mutual fund can invest in many different stocks, bonds or cash equivalent securities. Such diversification has the potential to lower risk by spreading it among a number of investments. Based on the fund’s investment objective, a professional portfolio manager makes investment decisions for the fund.
Some mutual funds are aggressive, while some have more conservative objectives. The range of different investment objectives means that you can choose a fund that closely matches your own financial goals, objectives and risk tolerance.
Writer Thaddeus Toal is a financial advisor in Mclean, Va., and can be reached at (800) 488-4380 or (703) 790-7051.
This article doesn’t constitute tax or legal advice. Consult your tax or legal advisors before making any tax- or legally related investment decisions. This article is published for general informational purposes and isn’t an offer or solicitation to sell or buy any securities or commodities. Any particular investment should be analyzed based on its terms and risks as they relate to your specific circumstances and objectives.
