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Different Types of Investments

Here is a general overview of some typical investment opportunities. Be sure to research in more depth if one of these ideas looks interesting.

Mutual funds

There are many types of mutual funds, each with its own unique purpose and strategy

A pool of money, provided by individuals, companies and various organizations, mutual funds are a popular, easy and non-stressful way to invest in the stock market. Mutual funds have a "fund manager," who invests the money we investors have contributed.

A fixed-income mutual fund works to earn the highest yield possible while avoiding much of the risk, while the objective of the long-term growth mutual fund is to outstrip the Dow or Standard & Poors 500 in any given year. It carries more risk and historically, seldom achieves its goal.

One of the intriguing things about mutual funds is their diversity. There are many types of mutual funds, each with its own unique purpose and strategy. For instance, while some mutual fund portfolios invest only in blue chip companies, others invest in the opposite: start-up companies. The investor has a wide range of opportunities for investing that fit his or her own particular style and comfort zone.

Another plus concerning mutual funds is the fact that they are managed and monitored by a full time professional, the fund manager, who spends a good portion of each day studying and selecting the best investments. This takes some of the pressure off of the individual, who may not have the time or desire to gain the in-depth education necessary to successfully invest in each of these companies on his or her own. This is not to say you should fly into mutual fund investing without first doing some careful, thoughtful research, however.

After you have studied the various investment opportunities and have found one you like, be sure to check out its rankings with Morningstar or Standard & Poors (the S&P). You can get some idea of how the mutual fund you're interested in has been performing.

One way to begin investing in mutual funds is through your already-existing brokerage account, where you can buy mutual fund shares just like other shares of stock. If you haven't set up a brokerage account and you would rather not, find the particular mutual fund's webpage and learn more about it. If you prefer, you can make a telephone call. You will be sent information and an application.

As with many other investments, mutual funds often have a minimum initial investment amount. These can run anywhere from $25 to more than $5,000. Note, though, that if your purpose is to fund a retirement account of some type, like a 401K or a Roth IRA, this initial investment requirement is generally waived or lowered, especially if you are willing to set up automatic withdrawals from a bank account in order to make regular investments.

Dollar-cost averaging

This is a strategy designed to limit your long-term market risk and hopefully bring the added bonus of a higher net profit.

With dollar-cost averaging, the investor purchases small amounts of securities over a longer period of time, thus spreading out his or her cost basis over several years, which offers protection against changes in the market price. An investor who is actively following dollar-cost averaging determines exactly how much he or she can invest every month then selects an investment that can be held for the long term, at least five to ten years. The investor chooses the interval to contribute, say weekly, monthly or quarterly. If possible, it is a good idea to have these contributions set up as automatic withdrawals.

Index funds

Index funds are mutual funds that are passively managed, and reduce the possibility of company-specific risk. These are good funds to get into with dollar-cost averaging and save the investor even more money because the management fees are much less than actively-managed mutual funds. Over the long term, an investor can save thousands of dollars by investing this way. The fees he or she would have paid to a mutual fund manager remain instead in his or her account, earning interest.

Blue chip stocks

You will find as you begin researching the stock market that there are many different types of equity investments. Some of the types are common stock, convertible stock, restricted stock and preferred stock. Blue chip stocks are those that are considered safe and profitable. Wal-Mart, Exxon-Mobile and Coca-Cola are examples of blue chip stocks. These stocks have proven their worth and generally offer attractive dividends.

Bonds

When an investor agrees to loan money to a company (or other entity) in exchange for a pre-determined interest rate, he or she has purchased a bond.

The interest an investor can earn depends on the stability and strength of the company. Blue chips are considered stable, safe and nearly exempt of risk.

Governments, some institutions, corporations and municipalities can issue bonds.

Why issue bonds? Companies, as they grow, generally don't amass enough wealth to pay for all their supplies and necessary items internally. Issuing bonds makes it possible for the company to borrow money from investors. In return, the company agrees to pay the investor interest at certain intervals for a specific length of time. In this case, you could think of the investor as a bank giving the company a loan.

Although bonds don't make as much capital for the investor as stocks can, they do have advantages. Investors, or bondholders, can feel confident and secure that the money they invested will be returned to them unless the company goes bankrupt. Bonds can provide income at set intervals, which can be good for retired people, for instance. There are tax advantages to owning bonds. Certain types of bonds issued by governments or municipalities in order to build bridges or roads, etc, offer a tax-exempt status.

There are different types of bonds, like HH Savings Bonds, Series EE Savings Bonds, Municipal Bonds and Corporate Bonds, so if they are of interest to you, research them to figure out which type would be most beneficial to you.

Ultra-short bond funds

This type of mutual fund invests in fixed-income securities. The reason they are called "ultra-short" is because of the very short time period in which they mature. Like other mutual funds, these bond funds invest in various securities and offer a wide range of opportunities.

The ultra-short bond fund does carry more risk than, say, a certificate of deposit or the money market fund. The reason for this is because ultra-short bond funds have the freedom to invest in more opportunities, whereas money market funds can only invest in certain specific areas, like the government. Money market funds work to keep their net asset values at a stable amount, while the ultra-short bond fund's net asset value can vary. A CD is safer because it is insured by FDIC. Ultra-short bond funds and money market funds are not. The interest earned by ultra-short bond funds can vary due to things like the maturity date of the fund's investments, sensitivity to changes in the interest rate, and the credit quality of the fund's investments. Read the fund's prospectus and understand the risks fully before committing yourself.

For more information on mutual funds of all kinds, you can visit the website www.sec.gov/investor.shtml.

Other types of investments

Equity-indexed Annuity

Even the name sounds complicated. The equity-indexed annuity is a special contract between you, the investor, and an insurance company. Investors make either lump-sum contributions or a series of payments and the insurance company credits you with a return based on changes in an equity index, for instance, the Standard and Poors 500 Composite Stock Price Index. After the accumulation period, the insurance company makes payments back to the investors, following the terms of the contract, or the investor can choose to receive a lump-sum payment.

There is a risk of losing money with this type of annuity. The risks arise mostly from investors who have not thought things out completely and end up having to cancel the annuity before its maturation date. Generally, it takes several years for an equity-index annuity to break even and earn money. As with other types of annuities, you will pay a high surrender charge as well as tax penalties if you cancel the annuity before it has matured.

The equity-index annuity is a complex product and should not be undertaken lightly. Here are a few of the details that need to be fully understood before purchasing:
  • The interest rate cap
  • The margin/spread/administrative fee
  • The participation rate
  • The annual reset
  • The point-to-point
  • The high water mark
The last three items are indexing methods.

Typically, equity-indexed annuities are not registered with the Securities and Exchange Commission, but sometimes they are. It depends on the features the annuity provides. Understand how each aspect of the annuity works before you decide to purchase one.

Equity-linked CDs

Yes, these are certificates of deposit, but the rate of return to you is tied to the performance of stock indexes, such as the Standard and Poors 500. Generally, you will need to set up an equity-linked CD for five years.

Those who offer equity-linked CDs tout the protection from downturns in the markets because your original principal is not at risk. What is at risk is the interest. Investors should also understand that with the equity-linked CD, there may be no opportunity to cancel or redeem the CD prior to its maturity. Also, some of these types of CDs only allow redemption on specific dates, which might or might not be convenient for the investor. This is called the liquidity risk. Another risk that should be fully understood by investors is the way the CD return is calculated. Sometimes the return is calculated by averaging the closing price of the index over a period of time, rather than using the closing price at maturity. This can significantly affect the return to an investor. Understand the fine print before purchasing such an investment.

Equity-linked CDs are usually insured by the FDIC up to certain amounts allowed by law. This insurance covers the principal and any guaranteed interest on the CD.

CDs or Certificates of Deposit

CDs can be great investment tools. They carry a much lower risk than other investments, like stocks. Of course, the returns are generally lower than what can be achieved by investing in stocks.

CDs typically earn more interest than a regular savings account. Plus, they are federally insured up to $100,000.

When you purchase a CD, you invest a specific sum of money for a certain length of time. CDs offer varying lengths to maturity, six months, a year, five years or longer. The institution you have purchased the CD from in turn pays you interest. When your CD matures and you cash it in, you receive the original sum of money you invested, plus the interest it has earned. As usual, if you need to cancel your CD before maturity, you will end up paying fees and penalties all around, plus you will lose interest.

Brokerage firms, banks and independent sellers offer CDs. You can sometimes find a better deal through independent deposit brokers, because they have negotiated a higher rate of interest by promising to accumulate a certain number of investors. Check around for the best interest rate.

CDs come in all shapes and sizes including, fixed rate, variable rate, long term and other features.

Before deciding on a particular entity to purchase the CD from, find out all the details. For instance, make sure you understand exactly when the CD will mature. Choose a CD that will mature at a time that is convenient for you.

Watch out for the "call" feature that may be on some CDs. If the entity has put a "call" feature on the CD you are thinking about purchasing, that means they can terminate the CD after a certain length of time. You, the investor, are never given that opportunity. The bank or entity reserves that feature for themselves. Sometimes, if the interest rate falls, the entity might "call" or terminate the CD. If that happens, you will probably get back all of the original principal you paid up front, plus any interest already earned. But you'll have to start over again shopping for a CD, and this time, the interest will be lower.

If the interest rates rise, you cannot "call" your CD before its mature date. Your CD will slog on, earning interest at whatever rate it is on any given date, and if it lowers again, you may lose money.

Sometimes, the wording that banks and other entities use to sell CDs is misleading, so be sure you understand everything and get it in writing.

Confirm the interest rate you will be earning. Ask if it ever changes, that is, if the rate is fixed or variable.

If you purchase a CD through a deposit broker or independent seller, make sure you know what bank or entity is actually issuing the CD. This is especially important if you have other CDs in banks, because the new CD might end up in the same bank, and your total investment, if over $100,000 will lose its FDIC insurance.

Make sure you understand all the particulars about "early withdrawal" and what fees and penalties you will have to pay. Don't be fooled by ads that claim "no penalty for early withdrawal." Sometimes, these ads are deliberately misleading.

Make certain before you purchase a CD that the broker you are dealing with is legitimate. Deposit brokers are held to no government standards, and they do not need to be licensed.

Helpful numbers

To check the legitimacy of a deposit broker, you can call your state securities regulator or the National Association of Securities Dealers at 800-289-9999. This will get you to the Central Registration Depository.

Wondering about federal insurance and the FDIC? You can reach them by calling 877-275-3342 or visiting www.fdic.gov.

When you feel you have been misled by a deposit dealer, or you simply did not understand the particulars and have not had any success trying to remedy the situation with the dealer or their superiors, you can contact:

Office of Investor Education and Assistance
U.S. Securities and Exchange Commission
100 F Street, N.E.
Washington, DC 20549-0213

Include all the details and letters you have written in your efforts to correct the situation. They will try to help you resolve your issue with the selling entity, however, they are limited as to how much they can actually accomplish.

Problems with equity-indexed annuities can sometimes be resolved by contacting your state insurance commissioner. The Securities and Exchange Commission has a complaint form on their website, at www.sec.gov/complaint.shtml. Snail mail can be addressed to:

Securities and Exchange Commission
Office of Investor Education and Assistance
100 F Street, N.E.
Washington, D.C. 20549-0213

Additionally, other areas of this website carry valuable information about many aspects of investing and learning how to avoid fraud.

Questions or Complaints can be mailed to the SEC at:

Office of Investor Education and Assistance
U.S. Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549-0213
Fax: (202) 772-9295

Investing can be fun and profitable, but the bottom line remains the same: research and learn everything you can before parting with your money.

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