Investing 101

To begin understanding investment basics, keep in mind most investments fall into three broad categories – cash, bonds and stocks. Within these categories, there are many considerations when building a diversified portfolio.

Cash:
Cash can be held in a bank account or money market. It is used for general living expenses. It is important to keep an adequate level of emergency reserves to be used in the event of a job loss, disability, or other such catastrophes.

Bonds:
When you purchase a bond you are extending a loan to a company or government. For the use of your money, the company or government (the bond issuer) will make an interest payment to you on a set schedule, then return the loaned money (principal) at the end of the loan period. A bond owner does not have company ownership privileges although a bond may be backed by collateral (secured) which may be sold to satisfy a claim if the issuer defaults. Many bonds, however, are unsecured.

For bonds, the maturity and quality of a bond will affect your purchase decision. Maturity is the time until the principal will be returned to you. The quality rating of a bond gives you an indication of the likelihood you will receive the promised interest payments and return of principal. The financial position of the borrower determines the quality of the bond. As it strengthens or weakens, the quality rating rises and falls, respectively.

Stocks:
Companies issue stock to raise the funds needed to build new plants, purchase new equipment and, in general, expand. When you purchase a company’s stock you own a piece of a company. As an owner, you have a claim to the company’s earnings and assets. In addition, stockholders are usually given the right to vote in the election of board members and other matters of the company at stockholders’ meetings.

Stocks are characterized by market capitalization, style and industry sector. Market capitalization is the value of a company expressed in terms of its outstanding stock shares and its stock price (number of outstanding stock shares times current stock price equals market capitalization). Market capitalization boundaries can vary, but large capitalization companies (large cap stocks) generally have a market capitalization over $10 billion. Market capitalization for mid cap stocks ranges from $1 billion to $10 billion with small cap stock companies under $1 billion.

Stocks are further classified by style – value, growth and core (also known as blend). The stock for a company which is currently out of favor and whose stock price is inexpensive compared to the value of the company assets is considered a value stock. Think of it as a stock “on sale”. On the other hand, a company that has experienced continued, rapid growth momentum in its earnings would fall into the growth category. Think of this as a stock “on fire”. Any stock that is not characterized by a value or growth style is considered a core stock.

The industry sector for a company provides insight into what the company does to make money. Common industry sectors are: consumer discretionary, consumer staples, energy, financials, healthcare, industrials, information technology, materials, telecommunication services and utilities.

Asset Allocation:
Each investor must decide on the dollar amount or percentage of investment dollars they will direct to cash, bonds and stocks. Some of the factors to consider when choosing an asset allocation are: the amount of time until the funds will be needed, the amount of time the funds will need to last and the investor’s level of comfort with risk or value fluctuations.

Diversification:
By investing in stocks with different market capitalizations, styles and industry sectors, you reduce the overall risk of your portfolio. Just as the saying goes, ‘don’t put all your eggs in one basket,’ you don’t want to put all your investment dollars in one investment basket. Diversification in bond investing (exposure to bonds of different maturities, qualities and issuers) is equally important for risk reduction. However, diversification does not assure profit or protect against loss in a declining market.

Mutual Fund Investing:
For those with the time, money and inclination, a diversified portfolio can be built with individual bonds and stocks. However, for many, mutual funds play a valuable role in today’s investing. Mutual funds pool money from many people and invest in various securities. The fund manager directs the investment of the fund money according to the fund’s objective or investment style.

Mutual fund investing allows for diversification and professional management that otherwise may not be available to investors. This means a dollar invested in a mutual fund will provide exposure to tens, or even hundreds, of stocks or bonds. The mutual fund manager actively researches, selects and monitors the stocks and bonds for its investors.

Understanding the building blocks of investing is the first step in sifting through the almost limitless investment options. With knowledge and experience you will find which investments will help you reach your financial goals given your risk tolerance.

This commentary is for informational purposes only and should not be used as the primary basis for an investment decision. Consult your advisor. Investment Advisory Services offered through Worley Financial Group, Inc., a Registered Investment Adviser.

Juli Erhart-Graves is a CERTIFIED FINANCIAL PLANNER™ practitioner at Worley Financial Group, Inc. Juli’s fee-only practice provides financial planning and investment advisory services to middle-income individuals, couples and families. For more information, visit www.worleyfinancialgroup.com.