Types of Investments: Investing Series Part Three
| July 19, 2007 | Posted by Roshawn Watson under Uncategorized |
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Stock: Did you know that stock have outperformed every other asset class? By purchasing stock, you own a small portion of a company. Companies issue stocks to generate cash, and the greater number of stocks you own the greater your financial stake. An increase in the stock price (appreciation) makes your stock worth more. If one sells while stock price is high, he or she gets capital gains. Moreover, some companies will issue dividends, which are portions of their profits that are paid to individual investors as cash. Shareholders will either receive a check or will instruct their brokers to automatically reinvest this money to buy more companies shares. Personally, I reinvest my dividends. One strategy of stock investing is to try to buy great companies at low prices (value investing). To determine if a stock is undervalued (i.e. a good one to buy), look at its price to earning (P/E) ratio. For example, a couple years ago the average P/E for stocks in the S&P; 500 was 28.5, so an undervalued stock would have a P/E ratio less than 28.5.
Standard and Poors 500 (S&P;): The S&P; index is comprised of 500 companies, mostly American blue chip companies. By representing 70% of all U.S. publicly traded companies, the S&P; 500 is often regarded as a broad enough to reflect the entire U.S. stock market. Nonetheless, its market capitalization is pretty large. Adding to its popularity, the S&P; 500 is also closely associated with the world’s largest mutual fund (Vanguard 500) and first exchange traded fund (will discuss next week).
Dow Jones Industrial Average (DJIA): The DJIA contains 30 of America’s largest and best known companies. Its performance is generally considered to reflect America’s economy.
Nasdaq: This is another index reflecting some of the biggest domestic and foreign indexes. Nasdaq 100 comprises of many tech stocks and has been among the top performing indexes in the past decade. Generally, the companies tend to be smaller and newer.
Bonds: Historically, returns on bonds trial stock returns; however, bonds do have some advantages. They are sometimes much less volatile than stock, can increase your income, and can provide some tax free income (municipal bonds are exempt from federal tax). There are several types of bonds: treasury bonds, corporate bonds, and municipal. Three popular treasury bond are: EE series (typical savings bond), I bond (inflation indexed savings bond), and Treasury Inflation-Protection Securities (TIPS). The creator of the Savings Bond Informer, Daniel J. Pederson, suggests that an I Bond should outperform a Series EE bond if its original base rate is ≥ 3.5% (Investing Bible, 2001). Functionally, a bond means you are loaning a company (i.e. corporate) or the government (Treasury) money for a pre-specified rate of return. The amount you loan is referred to as principal. The face value of the bond is known as par. If the current interest rates are lower than what your designated bond rate of return, you make money. Unfortunately for investors, this is when many companies call the loan (pay you pack). Lastly, beware of junk bonds; assess them with the Standard and Poor’s rating system. http://www.investopedia.com/terms/b/bondrating.asp
Next week: We will continue explaining the types of investments (including investment vehicles such as IRAs and 401Ks), and I will give you some picks from my personal porfolio.
© Copyright 2007, Roshawn Watson, Pharm.D.
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