Investing: Part B – “Your Money has a Job in the Stock and Bond Markets!”

The Many Ways to Earn Money
AKA “Multiple Streams of Income”
The Mini-Series

Investing – Part B: Stocks, Bonds, Mutual Funds

“Your Money has a Job in the Stock and Bond Markets!”

Stock Market: Wikipedia defines stock market as a public market for the trading of company stock and derivatives at an agreed price. These are securities listed on a stock exchange as well as those only traded privately.

The stocks are listed and traded on stock exchanges. Stock Exchanges are entities of a corporation or mutual organization who specialize in bringing buyers and sellers to a listing of stocks and securities. The stock market in the United States includes the trading of all securities listed on the NYSE, Euronext, the NASDAQ, the Amex, as well as on the many regional exchanges, e.g. OTCBB and Pink Sheets. European examples of stock exchanges include the London Stock Exchange, the Deutsche Börse.

Bond Market: Wikipedia Defines the bond market (also known as the debt, credit, or fixed income market) as a financial market where participants buy and sell debt securities, usually in the form of bonds.

Nearly all of the average daily trading volume in the U.S. bond market takes place between broker-dealers and large institutions in a decentralized, over-the-counter (OTC) market. However, a small number of bonds, primarily corporate, are listed on exchanges.

References to the “bond market” usually refer to the government bond market, because of its size, liquidity, lack of credit risk and, therefore, sensitivity to interest rates. Because of the inverse relationship between bond valuation and interest rates, the bond market is often used to indicate changes in interest rates or the shape of the yield curve.

Mutual Fund: Wikipedia defines a mutual fund as a professionally managed type of collective investment scheme that pools money from many investors and invests it in stocks, bonds, short-term money market instruments, and/or other securities. The mutual fund will have a fund manager that trades the pooled money on a regular basis. The net proceeds or losses are then typically distributed to the investors annually.

There are three basic types of mutual fund investment companies in the United States:

  1. Open-end funds, also known in the U.S. as mutual funds
  2. Unit investment trusts (UITs)
  3. Closed-end funds

Similar funds also operate in Canada. However, in the rest of the world, mutual fund is used as a generic term for various types of collective investment vehicles, such as unit trusts, open-ended investment companies (OEICs), unitized insurance funds, and undertakings for collective investments in transferable securities (UCITS).

Note:You must have discretionary income to Invest.

Discretionary income is your income after subtracting taxes and normal expenses (such as six-months of saving, housing, utilities, insurance, credit card and other loan payments, medical, education, transportation, maintenance, child support, inflation, food, entertainment, and everything it costs you to maintain your standard of living). Unless you are comfortable with “cutting costs so you can invest and grow your wealth”, I do not recommend setting yourself up to quit investing. Therefore, make sure you are using discretionary income with which to invest.

This is the extra money you have to either play with or invest. This varies with each person and each household. If you want to build wealth, you must have:

PLAY MONEY = MONEY TO INVEST = Gross income – taxes – saving – standard of living costs.

You earn money by placing your discretionary income into the hands of other responsible parties and they pay you to use your discretionary income. This is your return on investment. It can create money for you in several forms: interest, dividends, capital gains, tax savings, etc.

Broadly speaking, there are three major types of financial institutions:

  1. Deposit-taking institutions that accept and manage deposits and make loans (this category includes banks, credit unions, trust companies, and mortgage loan companies);
  2. Insurance companies and pension funds; and
  3. Brokers, underwriters and investment funds.

For this Part (B) we will deal with financial institutions as described above in parts 2 and 3. These institutions are not hard to find or deal with. There are your local and on-line stock brokerage companies, your company’s pension and 401K plan administrators and, insurance companies. Local banks or credit unions may also provide this service. You can set up accounts at their physical facility, on their web sites, or by calling them on the phone.

Investing Complexity:

Investing is a very broad, complicated category. Investing in its most basic definition is taking your discretionary income and putting it into something or giving it to someone for the purpose of having the “something or someone” make a return on your money.

There are many investments and they vary greatly in …

  • Their risk to reward ratio.
  • Their minimum investment
  • How they pay you.
  • The amount of expertise required to participate in them.

Investing “Vehicles:”

This will be a short, simple list you can use and will be limited to the basic financial market investment vehicles. As you build your wealth, you will be able to flex your financial strength by using experts in the other investment arenas to assist you in building your wealth to where you want it.

Stocks

  • These are instruments that signify an ownership position (called equity) in a corporation, and represent a claim on your proportional share in another corporation’s assets and profits. Ownership in that company is determined by the number of shares you own divided by the total number of shares outstanding.
    • For example, if a company has 1000 shares of stock outstanding and you own 50 of them, then you own 5% of the company.
  • Most stock also provides voting rights, which give you, the shareholder, a proportional vote in certain corporate decisions.
  • Only a certain type of company called a corporation has stock; other types of companies such as sole proprietorships and limited partnerships do not issue stock.
  • To purchase stocks, you must work with a broker. This can be an individual with a broker’s license, a brick and mortar brokerage firm, or an on-line brokerage company.

Bonds

  • These are debt instruments issued for a period of more than one year with the purpose of raising capital by borrowing.
  • The Federal government, states, cities, corporations, and many other types of institutions sell bonds.
  • Generally, a bond is a promise to repay the principal along with interest (coupons) on a specified maturity date.
  • Some bonds do not pay interest, but all bonds require a repayment of principal.
  • When you buy a bond, you become a creditor of the issuer. However, you do not gain any kind of ownership rights of the issuer.
  • On the other hand, you have a greater claim on an issuer’s income than a shareholder in the case of financial distress (this is true for all creditors).
  • Bonds are often divided into different categories based on their tax status, credit quality, issuer type, maturity and secured/unsecured (and there are several other ways to classify bonds as well).
  • U.S. Treasury bonds are generally considered the safest unsecured bonds, since the possibility of the Treasury defaulting on payments is almost zero.
  • The yield (your money making you money) from a bond is made up of three components: coupon interest, capital gains and interest on interest (if a bond pays no coupon interest, the only yield will be capital gains).
  • A bond might be sold at above or below par (the amount paid out at maturity), but the market price will approach par value as the bond approaches maturity.
  • A riskier bond has to provide a higher payout to compensate for that additional risk.
  • Some bonds are tax-exempt, and these are typically issued by municipal, county or state governments, whose interest payments are not subject to federal income tax, and sometimes also state or local income tax.
  • To purchase bonds, you need significant disposable income and you must work with a broker. This can be an individual with a broker’s license, a brick and mortar brokerage firm, or an on-line brokerage company.

Mutual Funds

  • These are open-ended funds that are operated by an investment company which raises money from shareholders (which would be you and others) and then invests in a group of assets.
  • Mutual funds raise money by selling shares of the fund to the public, much like any other type of company can sell stock in itself to the public.
  • Mutual funds then take the money they receive from the sale of their shares (along with any money made from previous investments) and use it to purchase various investment vehicles, such as stocks, bonds and money market instruments.
  • In return for the money you give to the fund when purchasing shares, you receive an equity position in the fund and, in effect, in each of its underlying securities.
  • For most mutual funds, you are free to sell your shares at any time, although the price of a share in a mutual fund will fluctuate daily, depending upon the performance of the securities held by the fund.
  • Benefits of mutual funds include diversification (don’t put all of your eggs in one basket) and professional money management (person or persons who are experts at reading the markets and can act quickly to move large amounts of money to benefit you).
  • Mutual funds offer choice, liquidity, and convenience, but charge fees and often require a minimum investment.
  • A closed-end fund is often incorrectly referred to as a mutual fund, but is actually an investment trust.
  • There are many types of mutual funds, including aggressive growth fund, asset allocation fund, balanced fund, blend fund, bond fund, capital appreciation fund, clone fund, closed fund, crossover fund, equity fund, fund of funds, global fund, growth fund, growth and income fund, hedge fund, income fund, index fund, international fund, money market fund, municipal bond fund, prime rate fund, regional fund, sector fund, specialty fund, stock fund, and tax-free bond fund.

Topics to be covered in the next parts:

Financial market Foreign exchange market Derivatives market
Commodity market Spot market OTC market
Annuity market Index market Other

Benefits of Investing:

  • Earning is basically not dependent upon your skill, education, experience or locale.
  • You do not need to work for anyone to do this.
  • The benefits are all financial.
  • Not much time is required on your part.
  • Just decide how much you can invest, what you want to invest in, and who you trust to make your money grow.
  • Then, you give your disposable income to them, sit back, and watch it grow.
  • Do it over and over again on a regular basis and watch your wealth grow even faster.

Investing Limitations:

  • The benefits are not immediate. They take some time to take hold for you.
  • You need patience and trust.
  • You will have to do without the disposable income that you have dedicated to the investment.

Investing Resources:

Previous Article in this Series: Investing: Part A

The Next in this Series: Investing – Part C

Gary

About Gary

I am retired, but not tired. I still want to be valuable to others. I know that others are valuable to me. After looking back on six decades, I have asked myself this question: “What do I believe?” My mind filled up. My heart started beating faster. My spirit soared. I post blogs to share what my mind is working on, what my heart believes would help others and, what my spirit is communicating to me. What do I believe, you ask? Decisions dictate your path In love, not hate In tolerance, not prejudice In health, not sickness In wealth, not poverty In kindness, rudeness In happiness, not sadness In encouragement, not discouragement In faith, not doubt In courage, not fear I have been and will be challenged in each one of these beliefs, but the biggest belief is to stay positive and not turn negative. This belief helps me maintain all of the others.

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