Financial Planning Guide: Choosing Investments

Choosing your investments depends on your age, dependents, income, capital, tax bracket and your values. Compare the liquidity, rate of return, safety and tax benefits of each investment you consider, and view these with your situation and goals in mind. The most common investment vehicles are savings and checking accounts, certificates of deposit (CDs), money market funds, mutual funds, corporate stocks, government and corporate bonds, and U.S. agency or Treasury obligations (T-bills). Here are some of the major choices:

Checking and savings accounts are no-risk, low-yield investments used mainly for money that must be safe and available.

A certificate of deposit (CD) is a deposit made, usually to a bank, for a specified amount of time for a specified rate. Terms vary between one and 120 months, with penalties for early withdrawal. Because the interest rates are only slightly higher than a savings account, certificates of deposit are usually good for short- term investments only.

Treasury bills or T-bills offer a guaranteed return backed by the U.S. Treasury. Minimum purchases are usually between $1,000 and $10,000 and maturities range from three months to 30 years. You can purchase them through banks, branches of the Federal Reserve Bank or through stockbrokers.

Corporate or common stock is a purchase of a piece of a corporation’s net worth. When a corporation succeeds, so do its owners – and when it fails, so do its owners. It’s worth consulting financial advisers or stockbrokers when investing in stocks. But keep in mind that you should allow plenty of time for a return; quick profits are rare. Don’t buy individual stocks unless you can diversify by investing in at least five companies in different industries. And remember, it’s more economical to buy in “lots” of at least 100; the transaction cost you pay will be less. To diversify broadly and minimize costs, many investors use mutual funds instead of buying individual stocks (see below). Financial planners often recommend automatically reinvesting your dividends to purchase more shares of stock.

Bond ownership makes you a creditor of a corporation or a government. You loan money and receive a fixed interest rate for the use of it. At the maturity date, you receive all of your principal. However, before the maturity date, the market value is not guaranteed. The value of a bond may increase or decrease depending on changes in interest rates and credit quality. Corporate bonds are usually backed by collateral, or a promise to pay. It’s prudent to check the financial standing of the corporation before purchasing a bond, and the rating of a bond by a professional bond-rating service.

A money market fund is relatively safe, liquid and low-risk. Many offer check-writing privileges. A money market fund is a pool of money invested in high-yielding, short-term vehicles. They allow you to buy a share in a diversified mix of investments that you as an individual would likely not be able to duplicate. As an investor, you receive a share of the yield realized from the fund’s investments. The rate of return for money market funds is usually higher than for a checking account, but the minimum investment is higher, usually $1,000. Like all uninsured products, the yield will fluctuate with varying market conditions

Mutual funds generally invest in common stocks and bonds and offer automatic, broad diversification. Investing in a mutual fund is buying a share of the fund’s portfolio – its particular collection of stocks and bonds. Your investment entitles you to share any dividends or interest income earned by the stocks and bonds, as well as any profits or losses realized from the sale of these securities.

Mutual funds do not guarantee return and pose a higher risk than a savings or money market account. Your principal is at risk. However, investments in one or more mutual funds offer more diversity and greater potential returns than investing directly in the stocks and bonds of a small number of companies. They are generally suited to investors who are looking for diversification and professional management, but lack the resources, time or desire to deal with the research and paperwork that stock investments require.
Some mutual funds invest in a spectrum of securities while others focus on a particular industry or geographical area. Each fund has a stated investment objective outlined in its prospectus. Socially responsible mutual funds also outline their social and environmental criteria in their prospectuses.

If your objective is long-term appreciation of your investment, look for a growth fund. If you hope to use your return as current income, look for an income fund. A balanced or “growth and income” fund invests in high dividend stocks as well as fixed-income securities that provide for both.