If you’re looking to invest but don’t know quite where to start, there are some basic types of financial instruments you should be aware of. These instruments are readily available for investment, but each carries its own level of risk. Certificates of deposit, treasury securities, bonds and equity securities are among the most basic financial instruments you can add to your portfolio.
Certificates of Deposit
Most commercial banks offer certificates of deposit that pay a fixed amount of money for six months, one year or another designated time period. You earn interest on the CDs and your investment is protected. According to the U.S. Securities and Exchange Commission, CDs have federal deposit insurance up to $250,000, but that amount is subject to change. The advantage of CDs is that you are guaranteed an income in almost all cases. One of the disadvantages it that if you withdraw early you might have to pay a penalty. Also, the returns on CDs tend to lag well below other types of investments.
Treasury securities issued by the U.S. government are debt instruments that pay varying levels of interest, over varying time periods. The types of securities that the government issues include floating rate notes, Treasury bills and Treasury bonds. Each type of security has its own characteristics, making it easier for you to find an instrument that matches your return requirements. For instance, Treasury bonds can have lengthy maturity periods such as 30 years, while other securities have maturities of five years or less. The advantage of Treasury securities is that they are usually easy to sell on the secondary market, but they typically pay a low rate of interest relative to other financial instruments.
Public and private entities issue bonds, which are either secured by collateral or unsecured and pay varying amounts of interest. For instance, timeshare companies often issue bonds secured by timeshare mortgages. These are known as asset-backed securities. Bonds typically sell for a premium or a discount, impacting the effective interest that you earn. Bonds also come with a rating that differs by the agency rating the bonds. Investing in corporate bonds always comes with risk, but bonds with low ratings and high interest rates tend to be the riskiest. Bonds are advantageous because they typically pay higher rates of interest relative to treasury securities. But there is also a higher risk of default, which is a distinct disadvantage.
If you’re looking to invest in equity securities, you can buy common shares or preferred shares of a company’s stock. When you buy shares, you’re buying an ownership stake in a company. Some common shares pay a dividend, while others do not. Preferred shares typically pay a fixed amount to shareholders, making them more like a debt instrument as opposed to an equity security. Both publicly traded and privately held corporations issue stock, but only a publicly traded company's shares are available to the public on a regular basis. The price of a stock is subject to varying levels of volatility, due to factors ranging from economic stability to the competitiveness of a company in the marketplace. Newly list companies with short track records and stiff competition tend to experience high price volatility.