INVESTMENTS

There was a time when many individuals thought that investing was for the rich and that very few people could afford to take on the risk that investments appeared to require. But, of course, times have changed; many Americans do invest. They realize that their long-term financial security does not look promising if it is based only on Social Security and company-provided pension plans. Both the numbers of people investing and the types of investments available have increased, especially since the early 1980s. The possibilities for investing funds are far more extensive than just stocks or bonds. In this entry, ten of the most popular investment instruments, from A (annuities) to Z (zero coupon bonds), will be discussed.

ANNUITIES

An annuity provides a means of reducing the risk of outliving one's investment income after retirement from full-time employment. Purchasing an annuity may be a possible solution to reducing this risk. An annuity may be considered the opposite of a traditional life insurance policy. An individual who buys insurance agrees to pay annual premiums to an insurance company. In return, the company will pay, according to instructions agreed upon at the time of purchase, the face value of the policy in a lump sum to beneficiaries when the purchaser dies.

By contrast, an individual who buys an annuity pays the insurance company a sum of money and, in return, will receive a monthly income for as long as the purchaser lives. Naturally, the longer one lives, the more money is received. The holder of an annuity never outlives the return, regardless of how long-lived the individual is. Life insurance protects one's beneficiaries against financial loss as a result of the purchaser's dying too soon, while annuities protect purchasers against financial loss as a result of living longer than their funds do.

Annuity income depends on life expectancy and is thus classified as life insurance. Understanding this is important because the classification allows the annuity's investment earnings to be treated as tax-deferred, with no tax on its accumulation until payments are received.

CERTIFICATE OF DEPOSIT

The concept of the certificate of deposit (CD) is simple. It is a savings instrument issued by a financial institution that pays the purchaser interest at a guaranteed rate for a specific term. When the CD reaches maturity, the investor receives the principal and interest earned. Unlike bond interest (paid periodically), the interest from a CD usually compounds, which means interest is earned on prior interest earned also. An investment in CDs, up to $100,000, is insured by the federal government.

CDs are appealing for safety, liquidity, and convenience. Less appealing is the lower yield when compared with other investments. CDs make sense as emergency funds, savings for short-term goals, a way to complete a long-term goal, and a place to "park" money while an investor seeks more profitable investments.

CORPORATE BONDS

A bond is a form of debt issued by a corporation in exchange for a sum of money lent by the buyer of the bond. The issuer of the bond promises to pay a specific amount of interest at stated intervals for a specific period. At the end of the repayment period (on the maturity date), the issuer repays the amount of money borrowed.

It is important to understand the differences between corporate bondholders and corporate stockholders. The holder of a corporate bond is a creditor of the corporation that issues the bond, not a part owner, as is a stockholder. Therefore, if the corporation's profits increase during the term of the bond, bondholders receive no benefit since the amount of interest they receive is fixed at the time the bond is purchased. On the other hand, the bondholders' investments are safer than those of the stockholders. Interest on bonds is paid out before dividends are distributed to stockholders. Furthermore, the claims of bondholders take precedence over those of the stockholders in the case of bankruptcy or liquidation.

When interest rates rise, bonds lose value; when interest rates fall, bonds become more attractive. Most bonds issued today are "callable," which means corporations can recall them if interest rates rise before the maturity dates.

GOLD

Some investors find gold an appealing investment. Gold has been used as money since biblical times. Several characteristics of gold have made it desirable as a medium of exchange and for investment. Gold is scarce. It is durable. More than 95 percent of all the gold ever mined during the past 5,000 years is still in circulation. It is inherently valuable because of its beauty and its usefulness in industrial and decorative applications.

Gold has been referred to as the "doomsday metal" because of its traditional role as a bulwark against economic, social, and political upheaval and the resulting loss of confidence in other investments, even those guaranteed by national governments.

As an investment, gold is not for the faint of heart or for people who desire a high level of predictability. Its value can fluctuate daily, owing to economic and political conditions. When interest rates in the United States fall, the dollar grows weaker in relation to other currencies. As a result, foreign businesspeople find U.S. investment less attractive, and some of them invest in gold instead. This forces the price of gold higher. When interest rates in the United States rise, the reverse occurs.

Investing in gold may be done in several ways: bullion, coins, shares and funds, and certificates. A number of companies specialize in the buying and selling of gold.

MONEY MARKET ACCOUNTS

Money market fund firms operate by combining many small investors' funds to accumulate the volume of money needed to buy money market instruments. Since the instruments purchased by the fund have differing maturities, the fund earns interest on a daily basis. Each investor receives a statement, usually monthly, of interest earned monthly. The amount earned on an investment varies continually as the current interest rates in the money market rise and fall.

A minimum deposit is required to open a money market account; __BODY__,000 is typical. Additional funds may be added to one's investment at any time, and the funds are completely liquid—one can make withdrawals whenever one wishes.

Another important point about this type of investment: Because of the liquidity of a money market fund, it is an ideal way to invest idle cash that might otherwise find its way into a low-paying passbook savings account. For example, placing the proceeds from the sale of securities into a money market fund until one has decided upon one's next investment venture is a good way of earning continuous interest on one's money.

MUNICIPAL BONDS

Municipal bonds are issued by local and state governments to raise money to provide services and to build schools, roads, water and sewer facilities, and other public works. In order to meet these expenses, communities borrow money from citizens and institutions by issuing debt obligations known as municipal bonds (munis), which are tax-exempt.

Among the more popular varieties of municipal bonds available are the following:

General obligation (GO) bonds. These are backed by the full faith and credit of the issuing agency. Interest payments on GO bonds are supported by the taxing authority of the state or city government and are generally considered the safest form of municipal bond.
Revenue bonds. These are usually issued by a government agency or commission that has been charged with operating a self-supporting project, such as highway or bridge. The money raised through the sale of revenue bonds goes to finance the project, and the income realized from the completed project (tolls, for example) is used to pay the interest and principal on the bonds.

For the investor, the most important advantage of municipal bonds is that they earn interest income, which is tax-free at the federal level. If investors live in the state in which the bonds are issued, the bonds are usually free from state and local taxes as well. The downside of tax-free munis is high minimum investment requirements, lower yields, and the fact that the issuer can recall them before they mature.

MUTUAL FUNDS

Mutual funds are called mutual because a large number of investors' provided money to form a pool to be managed by knowledgeable investment professionals. The price of a share in the mutual fund is determined by the value of the fund's holdings. As the value of the stocks owned by the fund increases, the share price increases and the investors make a profit: If the value of the stocks decreases, the shares are worth less and investors suffer a loss. The price of a share in a mutual fund (determined by dividing the net value of the fund's assets by the number of shares outstanding) is usually announced once or twice a day. A mutual fund also earns dividends that may be paid directly to investors or reinvested to buy additional shares in the fund.

Therefore, mutual funds can make money for their investors in three distinct ways:

The shareholders receive dividends earned through the investment that the fund possesses.
If a security in the fund's portfolio is sold at a profit, a capital gains distribution will be made by the fund to its shareholders.
If the value of the fund's portfolio increases, the value of each share also increases.

Mutual funds offer an easy way to diversify money, control risk, and benefit from professional money management at a reasonable cost.

SAVINGS BONDS

The EE bond is a nonnegotiable security against the credit of the U.S. Treasury—nonnegotiable because once it is purchased, it cannot be resold to anyone else, but may be sold back only to the government at a fixed price. The bonds may, however, be transferred to someone else.

Series EE bonds are sold at half their face value and are available in denominations of $50, $100, $200, $500, __BODY__,000, $5,000, and $10,000. Thus savings bonds are available for as little as $25, making them a practical choice for the investor with only a minimal amount of money to set aside. It is possible to purchase EE bonds online at TreasuryDirect (http://www.savingsbonds.gov)—a government Web site that is run by the Bureau of the Public Debt, part of the U.S. Department of the Treasury—where the amount invested and what is paid differs from the paper EE bond just described.

Another type of savings bond is the I bond; it is sold at face value and will grow with inflation-indexed earnings for up to thirty years. The I bond can also be purchased online at TreasuryDirect.

There are advantages that both of these bonds possess:

Competitive: Their rates of return are generally comparable to other forms of savings and accrue interest monthly and compound semiannually.
Safe: They are backed by the full faith of the United States and are registered, which is helpful if bonds are lost, stolen or mutilated.
Convenient: Bonds may be purchased at banks, online at TreasuryDirect, or where one works, if one's employer has such a deduction plan.
Accessible: They are easily redeemable after six months.
Tax benefits: The interest earned on savings bonds is exempt from all state and local income tax and is deferred for federal income tax until sale or maturity.

TREASURIES

Treasuries refers to a range of U.S. Treasury obligations. In a low-interest economy, many people switch to investments with higher yields, getting away from their traditional CDs. A safe and secure short-term investment that is an alternative for the CD is the Treasury bill (T-bill). Longer-term notes and bonds are also available.

Treasury obligations are tax-exempt at the state and local levels and are backed by "the full faith and credit" of the United States. The credit risk involved in this form of investment is considered practically nil. In comparison with similar obligations issued by corporations, Treasury obligations usually pay a yield, which is one or two percentage points lower. Many people, however, are willing to accept the slightly lower yield in exchange for the high level of safety.

There are four types of issues of Treasuries, which each require a minimum investment of __BODY__,000. These are tax-free at state and local levels and can be bought through a broker, bank, or the Treasury. The T-bill is a thirteen or twenty-six-week instrument that is issued at a discount but pays face value at maturity. Treasury notes earn and pay a fixed rate of interest every six months and are issued in terms of two, three, five, and ten years. Treasury bonds are sold at thirty-year maturities and pay interest every six months. A fourth hybrid bond is a Treasury inflation-protected security, which provides protection against inflation based on the Consumer Price Index and is sold in terms of five, ten, and twenty years.

ZERO COUPON BONDS

Is there an instrument that lets an investor know exactly how much money will be available at a particular future date (whether it be for the education of one's child, retirement, etc.) and, if administered correctly, becomes tax deferred or even tax-exempt? Yes, the zero coupon bond meets these expectations.

Zero coupon bonds have some advantages over other types of long-term investments. They have become an excellent choice for individual retirement accounts, 401(k) plans, Keogh plans, and other pension funds, and most certainly for a child's college savings. They are therefore an ideal investment for investors who are more concerned about "outcome" rather than "income."

Bonds are debt obligations issued by a corporation or by a federal, state, or local government agency. When one buys a bond (usually at face value), one is buying a promise from the issuing institution to pay the amount of the face value of the bond at maturity.

Zero coupon bonds are sold at a price well below face value. Thus, these bonds are appealing to the small investor because they can be bought far more cheaply than ordinary debt obligations. The discount is usually from 50 to 75 percent.

SUMMARY

The variety of investments available provides varying advantages and disadvantages. A careful study of the different types in consideration of goals for investment and level of risk to be accepted is worthwhile. Such study provides the investor the basis for making decisions about the extent and nature of variability wanted in one's personal portfolio.