Stocks, bonds, and cash are the substance of a diversified portfolio.
Many investors - from the newest to the most experienced - focus on stocks, bonds, and cash to form the backbone of their portfolio. And they make that choice with good reason. These investments are easy to buy and sell, provide a wide range of choices, and have the potential when they're combined in certain proportions to provide the primary benefits of investing - an increased potential to meet your financial goals.
Each of these investment categories puts your money to work a little differently. And each can play a slightly different role when you allocate your assets and diversify your portfolio.
STOCKS Stocks are equity investments, or ownership shares in a business. When you and other investors buy shares, you actually buy part of the business. If it prospers, you have the potential to make money either because you're paid a share of the profits or because the value of the stock increases, or both. You can own stocks for as long as you like, or buy and sell them regularly, depending on your investment plan. While you can't predict the future, stocks have historically been stronger performers than other types of investments.
CASHCash is money you hold in readily accessible savings, checking, and money market accounts. When those accounts are insured, as bank accounts are, you can be confident of being able to withdraw the amount you deposit. You may also earn interest on the account value.
Keeping a portion of your investment principal in cash lets you take advantage of new investment opportunities as they arise. The risk with cash is that its purchasing power tends to be eroded by inflation over the long term.
BONDS Bonds are loans you make to corporations, governments, or agencies. They promise to pay back the full amount of the loan at a specific time plus interest, or a percentage of the loan amount, for the use of your money. Investors buy bonds, also known as debt securities or fixed-income investments, because they believe that they will get their investment amount back, and because they like the idea of regular interest income.
OTHER INVESTMENT OPPORTUNITIES
Stocks, bonds, and cash deserve the attention they receive, but they are not the only investments you're likely to make over your investing lifetime. A variety of other investment categories may also play a role in your portfolio.
ART AND COLLECTIBLES
FUTURES AND OPTIONS
Cash equivalents are short-term investments such as CDs and US Treasury bills that are easy to liquidate at little or no loss of value.
Real estate may increase in value and certain real estate investments provide tax advantages.
Annuities are tax-deferred investments designed to provide future income, at either a fixed or variable rate.
Art and collectibles are investments whose value varies based on quality, availability, and fashion.
Gold and other precious metals are investments of enduring worth, though their prices vary as supply and demand changes.
Futures and options are derivative investments that change in value as the products they're linked to change in price.
BUILDING A PORTFOLIO
Your goal as an investor is to build a balanced and diversified portfolio, or collection of investment categories, also known as asset classes. You may emphasize various combinations of these classes at certain points in your life or under certain market conditions. Using a strategy known as asset allocation, you assign a percentage of your portfolio to each of the classes you're including.
INVESTMENT VOCABULARY Stocks and bonds are types of securities, a term that once referred to the documents companies and governments issued to represent ownership. Today most investment information, including records of ownership, is stored electronically. You don't get stock or bond certificates - but the name securities has stuck.
It's also helpful to know the terms product and vehicles, since you're apt to hear them when investing is discussed. Product is sometimes used to mean something in which you can invest, including but not limited to securities, and vehicle often refers to an account or arrangement through which you invest, such as a 401(k) or individual retirement annuity (IRA).
RISK AND REWARD
With all of these investments there's an expectation of return, or earnings, and an element of risk. And in general, the greater the chance for a substantial return, the greater the risk of losing some or all of your principal. While it's almost impossible to predict any investment's future behavior accurately, it's fair to say that you can achieve a better tradeoff between risk and return with a carefully allocated portfolio than with one that's concentrated in just one or two classes or is assembled randomly.