Investment Vehicles Articles

Article / Updated 09-01-2023

In a down economy, U.S. savings bonds are one of the safest investments you can make. Savings bonds are nonmarketable securities — when you purchase them, they’re registered to you and you can’t sell them to another investor. Uncle Sam offers two types of savings bonds, Series EE and Series I, which are backed by the full faith and credit of the U.S. government and are considered the safest of all investments. Here’s more info on each type: Series EE bonds: These bonds earn a fixed rate of return set by the U.S. Treasury. They’re accrual bonds, which means the interest accumulates and is compounded semiannually (rather than being paid to the owner as it’s earned each month). If you hold one of these bonds, you receive the interest when you redeem the bonds. Series I bonds: The interest you earn from I bonds comes in two parts: A fixed-rate component established when you purchase the bond A second component that’s equal to the rate of inflation, adjusted semiannually (based on the consumer price index for March and September) Although the fixed-rate interest component for Series I bonds is low, these bonds help protect you against inflation. If inflation goes up, so does the interest rate you earn because the variable-rate portion is adjusted every six months; for example, when the fixed-rate component is 2 percent and the inflation adjustment is 5 percent, an investment in a Series I bond is guaranteed to return 7 percent. But remember, the total interest rate can also go down as the inflation adjustment decreases. For both bonds, the purchase limit is $5,000 per Social Security number for each calendar year. You can easily purchase and redeem the bonds in electronic format through the Department of the Treasury’s Web site. If you purchase the bonds electronically, you can get any denomination of $25 or more, including penny increments. The purchase price is equal to the face value. You can also purchase the bonds in paper form through various financial institutions and payroll savings plans. Paper I bonds are offered in denominations of $50, $75, $100, $200, $500, $1000, and $5,000; they’re purchased for their face value. However, you can get paper versions of EE bonds at half their face value; they’ll be worth face value at maturity. Paper EE bonds are offered in denominations of $50, $75, $100, $200, $500, $1000, $5,000, and $10,000. The interest on both bonds compounds semiannually for 30 years, but you don’t have to hold the bonds for that long. You can redeem the bonds after 12 months, but you pay a three-month interest penalty if you redeem the bonds within five years of the purchase date. As for tax treatment, U.S. savings bonds are exempt from state and local income tax. Federal income tax on interest earned can be deferred until redemption or final maturity, whichever occurs first. Tax benefits are available when you use the bonds for education purposes.

Article / Updated 08-31-2023

When, in November 2004, State Street Global Advisors introduced the first gold ETF, it was a truly revolutionary moment. You buy a share just as you would buy a share of any other security, and each share gives you an ownership interest in one-tenth of an ounce of gold held by the fund. Yes, the gold is actually held in various bank vaults. You can even see pictures of one such vault filled to near capacity (very cool!) at SPDR Gold Shares website. If you are going to buy gold, this is far and away the easiest and most sensible way to do it. You currently have several ETF options for buying gold. Two that would work just fine include the original from State Street — the SPDR Gold Shares (GLD) — and a second from iShares introduced months later — the iShares Gold Trust (IAU). Both funds are essentially the same. Flip a coin (gold or other), but then go with the iShares fund, simply because it costs less: 0.25 percent versus 0.40 percent. Strange as it seems, the Internal Revenue Service considers gold to be a collectible for tax purposes. A share of a gold ETF is considered the same as, say, a gold Turkish coin from 1923 (don’t ask). So what, you ask? As it happens, the long-term capital gains tax rate on collectibles is 28 percent and not the more favorable 15 percent afforded to capital gains on stocks. Holding the ETF should be no problem from a tax standpoint (gold certainly won’t pay dividends), but when you sell, you could get hit hard on any gains. Gold ETFs, therefore, are best kept in tax-advantaged accounts, such as your IRA. (This strategy won’t serve you well if gold prices tumble and you sell. Then, you’d rather have held the ETF in a taxable account so you could write off the capital loss.)

Article / Updated 08-23-2023

If you want to invest your money in companies that are smaller than small, you can invest in ETFs based on micro caps. These companies are larger than the corner delicatessen, but sometimes not by much. In general, micro caps are publicly held companies with less than $300 million in outstanding stock. Micro caps, as you can imagine, are volatile little suckers, but as a group they offer impressive long-term performance. In terms of diversification, micro caps — in conservative quantity — could be a nice addition to your portfolio, though not a necessity. Take note that micro cap funds, even index ETFs, tend to charge considerably more in management fees than you’ll pay for most funds. Micros move at a modestly different pace from other equity asset classes. The theory is that because micro caps are heavy borrowers, their performance is more tied to interest rates than the performance of larger cap stocks. (Lower interest rates would be good for these stocks; higher interest rates would not.) Micro caps also tend to be more tied to the vicissitudes of the U.S. economy and less to the world economy than, say, the fortunes of General Electric or McDonald’s. Given the high risk of owning any individual micro cap stock, it makes sense to work micro caps into your portfolio in fund form, despite the management fees, rather than trying to pick individual companies. To date, a handful of micro cap ETFs have been introduced. They differ from one another to a much greater extent than do the larger cap ETFs.

Article / Updated 08-17-2023

Stocks are well known for their ability to appreciate (for capital gains potential), but not enough credit is given regarding stocks’ ability to boost your income and cash flow. Given that income will be a primary concern for many in the coming months and years (especially baby boomers and others concerned with retirement, pension issues, and so on), I consider this to be an important consideration. The first income feature is the obvious — dividends! I love dividends, and they have excellent features that make them very attractive, such as their ability to meet or exceed the rate of inflation and the fact that they’re subject to lower taxes than, say, regular taxable interest or wages. Dividend-paying stocks, called income stocks, deserve a spot in a variety of portfolios, especially those of investors at or near retirement. Also, I think that younger folks (such as millennials) can gain long-term financial benefits from having dividends reinvested to compound their growth (such as with dividend reinvestment plans). The basics of income stocks I certainly think that dividend-paying stocks are a great consideration for those investors seeking greater income in their portfolios. I especially like stocks with higher-than-average dividends that are known as income stocks. Income stocks take on a dual role: Not only can they appreciate, but they can also provide regular income. The following sections take a closer look at dividends and income stocks. Getting a grip on dividends and their rates When people talk about gaining income from stocks, they’re usually talking about dividends. Dividends are pro rata distributions that treat every stockholder the same. A dividend is nothing more than pro rata periodic distributions of cash (or sometimes stock) to the stock owner. You purchase dividend stocks primarily for income — not for spectacular growth potential. Dividends are sometimes confused with interest. However, dividends are payouts to owners, whereas interest is a payment to a creditor. A stock investor is considered a part owner of the company they invest in and is entitled to dividends when they’re issued. A bank, on the other hand, considers you a creditor when you open an account; the bank borrows your money and pays you interest on it. A dividend is quoted as an annual dollar amount (or percentage yield), but it’s usually paid on a quarterly basis. For example, if a stock pays a dividend of $4 per share, you’re probably paid $1 every quarter. If, in this example, you have 200 shares, you’re paid $800 every year (if the dividend doesn’t change during that period), or $200 per quarter. Getting that regular dividend check every three months (for as long as you hold the stock) can be a nice perk. If the company continues to do well, that dividend can grow over time. A good income stock has a higher-than-average dividend (typically, 4 percent or higher). Dividend rates aren’t guaranteed, and they’re subject to the decisions of the stock issuer’s board of directors — they can go up or down, or in some extreme cases, the dividend can be suspended or even discontinued. Fortunately, most companies that issue dividends continue them indefinitely and actually increase dividend payments from time to time. Historically, dividend increases have equaled (or exceeded) the rate of inflation. Who’s well suited for income stocks? What type of person is best suited to income stocks? Income stocks can be appropriate for many investors, but they’re an especially good match for the following individuals: Conservative and novice investors: Conservative investors like to see a slow but steady approach to growing their money while getting regular dividend checks. Novice investors who want to start slowly also benefit from income stocks. Retirees: Growth investing is best suited for long-term needs, whereas income investing is best suited to current needs. Retirees may want some growth in their portfolios, but they’re more concerned with regular income that can keep pace with inflation. Dividend reinvestment plan (DRP) investors: For those investors who like to compound their money with DRPs, income stocks are perfect. Given recent economic trends and conditions for the foreseeable future, I think that dividends should be a mandatory part of the stock investor’s wealth-building approach. This is especially true for those in or approaching retirement. Investing in stocks that have a reliable track record of increasing dividends is now easier than ever. In fact, there are exchange-traded funds (ETFs) that are focused on stocks with a long and consistent track record of raising dividends (typically on an annual basis). Assessing the advantages of income stocks Income stocks tend to be among the least volatile of all stocks, and many investors view them as defensive stocks. Defensive stocks are stocks of companies that sell goods and services that are generally needed no matter what shape the economy is in. (Don’t confuse defensive stocks with defense stocks, which specialize in goods and equipment for the military.) Food, beverage, and utility companies are great examples of defensive stocks. Even when the economy is experiencing tough times, people still need to eat, drink, and turn on the lights. Companies that offer relatively high dividends also tend to be large firms in established, stable industries. Some industries in particular are known for high-dividend stocks. Utilities (such as electric, gas, and water), real estate investment trusts (REITs), and the energy sector (oil and gas royalty trusts) are places where you definitely find income stocks. Yes, you can find high-dividend stocks in other industries, but you find a higher concentration of them in these industries. To learn more about high-dividend stocks, and much more about stock investing, check out my book Investing in Stocks For Dummies. Heeding the disadvantages of income stocks Before you say, “Income stocks are great! I’ll get my checkbook and buy a batch right now,” take a look at the following potential disadvantages (ugh!). Income stocks do come with some fine print. What goes up … Income stocks can go down as well as up, just as any stock can. The factors that affect stocks in general — politics, megatrends, different kinds of risk, and so on — affect income stocks, too. Fortunately, income stocks don’t get hit as hard as other stocks when the market is declining because high dividends tend to act as a support to the stock price. Therefore, income stocks’ prices usually fall less dramatically than other stocks’ prices in a declining market. Interest-rate sensitivity Income stocks can be sensitive to rising interest rates. When interest rates go up, other investments (such as corporate bonds, U.S. Treasury securities, and bank certificates of deposit [CDs]) are more attractive. When your income stock yields 4 percent and interest rates go up to 5 percent, 6 percent, or higher, you may think, “Hmm, why settle for a 4 percent yield when I can get better elsewhere?” As more and more investors sell their low-yield stocks, the prices for those stocks fall. Another point to note is that rising interest rates may hurt the company’s financial strength. If the company has to pay more interest, that may affect the company’s earnings, which, in turn, may affect the company’s ability to continue paying dividends. Dividend-paying companies that experience consistently falling revenues tend to cut dividends. In this case, consistent means two or more years. The effect of inflation Although many companies raise their dividends on a regular basis, some don’t. Or if they do raise their dividends, the increases may be small. If income is your primary consideration, you want to be aware of this fact. If you’re getting the same dividend year after year and this income is important to you, rising inflation becomes a problem. Say that you have XYZ stock at $10 per share with an indicated annual dividend of 30 cents. The yield is 3 percent (30 cents @@ds $10). If you have a yield of 3 percent two years in a row, how do you feel when inflation rises 6 percent one year and 7 percent the next year? Because inflation means your costs are rising, inflation shrinks the value of the dividend income you receive. Fortunately, studies show that, in general, dividends do better in inflationary environments than bonds and other fixed-rate investments do. Usually, the dividends of companies that provide consumer staples (food, energy, and so on) meet or exceed the rate of inflation. This is why some investment gurus describe companies that pay growing dividends as having stocks that are “better than bonds.” Uncle Sam’s cut The government usually taxes dividends as ordinary income. Find out from your tax person whether potentially higher tax rates on dividends are in effect for the current or subsequent tax year. Stock dividends or company dividends? The term stock dividend is commonly used in financial discussions about the stock market. However, the reality is that dividends are not paid by stocks; they’re paid pro rata distributions of cash by companies. It may sound like I’m splitting hairs, but it’s a fundamental difference. Stock prices are subject to the whims of market buying and selling — one day the share prices are up nicely; the next day prices go down when that day’s headlines spook the market. Because the dividend isn’t volatile and it’s paid with regularity (quarterly usually), it’s more predictable. I think that investors should be in the business of “collecting cash flows” as opposed to fretting over the ebbs and flows of the market. What does that mean? If a hundred shares of a given dividend-paying stock provide, say, $100 per year in annual dividends, the income-minded stock investor should keep a running tally of annual dividend amounts. That way, they keep investing until they reach a desired income level (such as $2,000 annual dividend income) and feel confident that this dividend income can be relatively reliable and will keep growing as payouts grow from company operations. Lastly, keep in mind that technically a “stock dividend” is actually a pro rata distribution of stock (and not cash).

Article / Updated 08-14-2023

The basics of stock investing are so elementary that few people recognize them. When you lose track of the basics, you lose track of why you invested to begin with. Here's what's involved in stock market basics: Knowing the risk and volatility involved: Perhaps the most fundamental (and, therefore, most important) concept to grasp is the risk you face whenever you put your hard-earned money in an investment such as a stock. Related to risk is the concept of volatility. Volatility refers to a condition in which there is rapid movement in the price of a particular stock (or other security); investors use this term especially when there’s a sudden drop in price in a relatively short period of time. Assessing your financial situation: You need a firm awareness of your starting point and where you want to go. Understanding approaches to investing: You want to approach investing in a way that works best for you. Seeing what exchange-traded funds (ETFs) have to offer: ETFs are like mutual funds, but they can be traded like stocks. I think that every stock investor should consider ETFs as a positive addition to their portfolio strategies. For the details on all of these concepts, and much more, check out my book Investing in Stocks For Dummies. The bottom line in stock investing is that you shouldn’t immediately send your money to a brokerage account or go to a website and click a Buy Stock button. The first thing you should do is find out as much as you can about what stocks are and how to use them to achieve your wealth-building goals. Before you continue, I want to clarify exactly what a stock is. Stock is a type of security that indicates ownership in a corporation and represents a defined portion (measured in shares) of that corporation’s future success. The two primary types of stocks are common and preferred: Common stock: This type of stock entitles the owner to vote at shareholders’ meetings and receive any dividends that the company issues. Preferred stock: This type of stock doesn’t usually confer voting rights, but it does include some rights that exceed those of common stock. Preferred stockholders, for example, have preferential treatment in certain conditions, such as receiving dividends before common stockholders in the event of a corporate liquidation or bankruptcy. Additionally, preferred stock seeks to operate similarly to a bond for investors seeking stable income. Preparing to buy stocks Gathering information is critical in your stock-investing pursuits. You should gather information on your stock picks two times: before you invest and after you invest. Obviously, you should become more informed before you invest your first dollar, but you also need to stay informed about what’s happening to the company whose stock you buy, as well as about the industry and the general economy. When you’re ready to invest, you need to open a brokerage account. After you’ve opened a brokerage account, it pays to get familiar with the types of orders you can implement inside that account. Knowing how to pick winners When you get past the basics, you can get to the meat of stock picking. Successful stock picking isn’t mysterious, but it does take some time, effort, and analysis. And the effort is worthwhile because stocks are a convenient and important part of most investors’ portfolios. Recognizing stock value Imagine that you like eggs, and you’re buying them at the grocery store. In this example, the eggs are like companies, and the prices represent the prices that you would pay for the companies’ stock. The grocery store is the stock market. What if two brands of eggs are similar, but one costs $2.99 a carton and the other costs $3.99? Which would you choose? Odds are that you’d look at both brands, judge their quality, and, if they’re indeed similar, take the cheaper eggs. The eggs at $3.99 are overpriced. The same is true of stocks. What if you compare two companies that are similar in every respect but have different share prices? All things being equal, the cheaper price represents a better buy for the investor. But the egg example has another side. What if the quality of the two brands of eggs is significantly different, but their prices are the same? If one brand of eggs is stale, of poor quality, and priced at $2.99 and the other brand is fresh, of superior quality, and also priced at $2.99, which would you get? You would take the good brand because they’re better eggs. Perhaps the lesser eggs are an acceptable purchase at $1.99, but they’re overpriced at $2.99. The same example works with stocks. A poorly run company isn’t a good choice if you can buy a better company in the marketplace at the same — or a better — price. Comparing the value of eggs may seem overly simplistic, but doing so does cut to the heart of stock investing. Eggs and egg prices can be as varied as companies and stock prices. As an investor, you must make it your job to find the best value for your investment dollars. (Otherwise, you get egg on your face. You saw that one coming, right?) Market capitalization and stock value You can determine a company’s value (and, thus, the value of its stock) in many ways. The most basic way is to look at the company’s market value, also known as market capitalization (or market cap). Market capitalization is simply the value you get when you multiply all the outstanding shares of a stock by the price of a single share. Calculating the market cap is easy; for example, if a company has 1 million shares outstanding and its share price is $10, the market cap is $10 million. Small cap, mid cap, and large cap aren’t references to headgear; they’re references to how large a company is as measured by its market value. Here are the five basic stock categories of market capitalization: Micro cap (less than $300 million): These stocks are the smallest and, hence, the riskiest available. (There’s even a subsection of micro cap called nano cap, which refers to stocks under $50 million, but they’re not appropriate for this article.) Small cap ($300 million to $2 billion): These stocks fare better than the micro caps and still have plenty of growth potential. The key word here is potential. Mid cap ($2 billion to $10 billion): For many investors, this category offers a good compromise between small caps and large caps. These stocks have some of the safety of large caps while retaining some of the growth potential of small caps. Large cap ($10 billion to $200 billion): This category is usually best reserved for conservative stock investors who want steady appreciation with greater safety. Stocks in this category are frequently referred to as blue chips. Ultra cap or mega cap (more than $200 billion): These stocks obviously refer to companies that are the biggest of the big. Stocks such as Google and Apple are examples. From a safety point of view, a company’s size and market value do matter. All things being equal, large-cap stocks are considered safer than small-cap stocks. However, small-cap stocks have greater potential for growth. Compare these stocks to trees: Which tree is sturdier, a giant California redwood or a small oak tree that’s just a year old? In a great storm, the redwood holds up well, whereas the smaller tree has a rough time. But you also have to ask yourself which tree has more opportunity for growth. The redwood may not have much growth left, but the small oak tree has plenty of growth to look forward to. For beginning investors, comparing market cap to trees isn’t so far-fetched. You want your money to branch out without becoming a sap. Although market capitalization is important to consider, don’t invest (or not invest) based solely on it. It’s just one measure of value. You need to look at numerous factors that can help you determine whether any given stock is a good investment. Sharpening your investment skills Investors who analyze a company can better judge the value of its stock and profit from buying and selling it. Your greatest asset in stock investing is knowledge (and a little common sense). To succeed in the world of stock investing, keep in mind these key success factors: Understand why you want to invest in stocks. Are you seeking appreciation (capital gains) or income (dividends)? Timing your buys and sells does matter. Terms like overbought and oversold can give you an edge when you’re deciding whether to purchase or sell a stock. Technical analysis is a way to analyze securities through their market activity (past prices and volume) to find patterns that suggest where those investments may be headed in the short term. Do some research. Look at the company whose stock you’re considering to see whether it’s a profitable business worthy of your investment dollars. Understand and identify what’s up with “the big picture.” It’s a small world after all, and you should be aware of how the world can affect your stock portfolio. Everyone from the bureaucrats in Europe to the politicians in the U.S. Capitol can affect a stock or industry like a match in a dry haystack. Use investing strategies like the pros do. I’m very big on strategies such as trailing stops and limit orders, and fortunately, today’s technology gives you even more tools to help you grow or protect your money. Look outside the U.S. stock market for opportunities. It’s easier than ever before to profit from stocks offered across the globe! Find out more about investing in international stocks through American depositary receipts (ADRs) and international ETFs. Consider buying in smaller quantities. Buying stocks doesn’t always mean that you must buy through a broker and that it must be 100 shares. You can buy stock for as little as $25 using programs such as dividend reinvestment plans. Do as others do, not as they say. Sometimes, what people tell you to do with stocks is not as revealing as what people are actually doing. This is why I like to look at company insiders before I buy or sell a particular stock. This includes insider trading done by Congress. Keep more of the money you earn. After all your great work in getting the right stocks and making the big bucks, you should know about keeping more of the fruits of your investing.

Article / Updated 08-07-2023

Why is gold such an important commodity compared to other metals? The traits of ductility, malleability, quasi-indestructibility, and rarity can help you understand where gold derives its value: Ductility: Gold is a very ductile metal. In metallurgy, ductility measures how much a metal can be drawn out into a wire. For example, 1 ounce of gold can be converted into more than 50 miles of gold wire! This gold wire can then be applied in electronics and used as an electric conductor. Malleability: Pure gold (24 karat) is a very malleable metal and is prized by craftsmen around the world who shape it into jewelry and other objects of beauty. One ounce of gold can be transformed into more than 96 square feet of gold sheet! Quasi-indestructibility: Gold has high resistance levels and doesn’t easily corrode. Corrosive agents such as oxygen and heat have almost no effect on gold, which can retain its luster over long periods of time (think thousands of years). The only chemical that can affect gold is cyanide, which dissolves gold. Rarity: Gold is one of the rarest natural resources on earth. Most people don’t realize this, but only about 150,000 tons of gold have ever been produced since humans first began mining gold more than 6,000 years ago. To give you an idea of how little that is, all the gold in the world wouldn’t even fill up four Olympic-size swimming pools! And because most gold is recycled and never destroyed, a majority of gold is still in use today. About 15 percent of gold is recycled every year.

Article / Updated 08-07-2023

Returns on savings bonds are so low that they’ll never make you rich. In fact, returns are so low that large pension funds and other big investors don’t purchase savings bonds. However, for many individuals, savings bonds are the best approach for saving money. Factors favoring savings bond are that you can Save automatically. Employers who sponsor savings bond programs can automatically deduct amounts you designate from your paychecks to purchase bonds. Diversify your risk. If you already have investments in stocks and bonds, you may want to invest in savings bonds. Doing so adds a no-risk element to your investment portfolio. End up with a safe investment. In exchange for a low return, savings bonds offer absolute safety for the principal investment; they’re absolutely no-risk investments. Avoid paying any sales commission. Investing in saving bonds doesn’t require the services of a broker to help you purchase them. Invest minimal amounts. The minimum investment in a savings bond is $25. If you subscribe to an employer-sponsored program, the minimum amount you pay each week can be even lower. Pay no or low taxes. The difference between the purchase price and the redemption value of Series EE bonds and the payment made on HH bonds comes in the form of interest. Interest income is subject to federal income tax but not state or local income taxes. You can defer paying federal income tax on the interest until you cash in the bonds. Gain educational tax benefits. The Education Bond Program allows interest to be completely or partially excluded from federal income tax when the bond owner pays for qualified higher education expenses at an eligible institution or state tuition plan in the same calendar year the bonds are redeemed. Disadvantages of savings bonds include the fact that you Face penalties for early redemption. If you cash in your Series EE bonds after you’ve held them for six months, you’ll pay three months’ worth of interest — ouch! Series EE and Series I bonds cease paying interest after 30 years. Need to be careful when you redeem your bonds. Make sure that you know when interest is posted. If you redeem a bond right before interest is posted, you won’t reap your interest payment. If you redeem your bond early on in the same month that interest is posted, you may lose six months’ worth of interest. Sometimes you can spend and save at the same time. At BondRewards, you can shop online at your favorite stores (more than 150 online stores participate in the program) and receive a small percentage of your purchase price in the form of a U.S. Savings Bond. Check in your safe-deposit box or among the papers of elderly relatives for old bonds. More than $2 billion in savings bonds never have been redeemed.

Cheat Sheet / Updated 08-02-2023

If you're considering investing in commodities or commodities-backed instruments, you'll want to find out as much as you can about what you're investing in. Companies have to file quarterly and annual financial reports, and they provide a wealth of information that is very valuable to the investor. The premiere location for the trade of agricultural commodities is the New York Board of Trade (NYBOT), and you'll want to become familiar with it. When you do invest, you'll want to practice the magic word — diversification — and manage the risk/reward ratio for not just your individual securities, but for your overall portfolio.

Cheat Sheet / Updated 08-02-2023

Dividend investing is nothing new. However, following a dividend-investment strategy is new to many modern investors who've been focused solely on growth investing. If you count yourself among this crowd or are just starting out and plan on investing in dividend stocks, you need to know how to develop your strategy, find and evaluate potentially good dividend stocks, manage your portfolio, and avoid the most common and critical mistakes.

Cheat Sheet / Updated 08-02-2023

An ETF, or exchange-traded fund, is a relatively new investment product. It's something of a cross between an index mutual fund and a stock. ETF investing has grown exponentially in the past few years, and it makes sense for most individual investors to take a look adding ETFs to their portfolios.