MONEY 4 - STOCKS

THIS IS MY FOURTH POST ON UNDERSTANDING MONEY TOOLS

Money! Money! Money! Where do we buy stocks?  As we talked about previously, the Glass Steagall Act regulated more closely the financial industries and kept each type separate.  This Act disintegrated over a 20 year period from the late 1970s until 1999. Institutions within the financial industry all started looking the same.  The insurance companies, commercial banks, trust companies, brokerage firms and others provide similar services.  It’s the Walmart mentality that has occurred with the “financial big companies” drowning out the little guys and family businesses.  The little guy can’t afford the expenses.

Let’s discuss the management of your money in stocks.  Fee based money managers are many times preferred as their income doesn’t grow unless your portfolio grows.  Some money managers have a larger minimum account to open, let’s say $500,000 or more. 

At work you might have a 401-K Plan or one of the ERISA retirement plans that offer “mutual funds”.  A mutual fund spreads your investment risk amongst a partial ownership of many stocks, and you can even select what types of stock investments you want, e.g. higher risk when you are younger and won’t need the money for years, but perhaps will have greater growth, mid or large cap stocks, higher yielding stocks, or perhaps stocks that do good for humanity, oil and gas, high tech, foreign stocks, etc. 

There are many types of “sector” stock funds and you should work with a counselor or broker when making these selections. These sectors may be global stocks, a particular industry, “green” companies, companies that help people, etc. Mutual fund fees also vary and that should be considered although history and performance of the fund is most important.

Bonds and bond funds are another investment opportunity.  These instruments are safer with lower risk, very appropriate for troubled economic times and older people. Portfolios for older individuals might hold 50% or more in various bonds.  Nothing is 100% safe! A bond is an instrument of indebtedness paying an interest rate, versus a stock that perhaps pays a yield.  In the risk pecking order bonds are the safest, preferred stock next and then common stocks. There are different types of bonds, the most popular being Federal, State, County, City (municipals) and corporate.

How is risk created on these?  Default is one and interest rate fluctuations number two. If you need to go to the secondary market to sell the bond before maturity it will sell at market value.  US Bonds have the least risk. The US government stands behind the bonds and can print money or increase taxes if needed to pay off maturing bonds, therefore the interest rate is the lowest. Most US bonds are 10 to 30 years in duration.  Shorter term instruments of US indebtedness are Treasury Bills (up to one year in length) and notes from one year on as a mid-range investment vehicle.

If interest rates go up and you need to sell your bond, you may not get face value for the bond, but a lesser amount equating to what interest rates are going for.  Conversely, if interest rates go down and you hold a bond that pays a higher interest rate, your bond is worth more than face amount.

There are different types of bond funds.  Two of note is an open end bond fund and a closed end bond fund.  If you think interest rates will go down, buy a closed end fund as the value of the fund will go up.  This type of fund is closed and will not add to the bonds thus lowering the overall interest rates. If you think interest rates are going up, buy an open end bond fund as the fund will keep buying new bonds into the portfolio at higher interest rates.

Corporate bonds are issued by corporations to raise money. Like any bond there is risk that the company will be able to pay the interest on the bond and then the face value upon maturity. Most bonds are also “callable” which can disturb your financial planning.  If interest rates go down, corporations and municipalities may call their bonds in and pay off the bond, and then refinance the debt at a lower interest rate. Of course, brokerage firms are all too happy to assist as they make fees in so doing.  Like stocks you can buy bonds through your broker or bank.

You can obtain ratings on bonds from objective independent companies like Moody’s and Standard and Poors.  Bonds are rated with classes of A’s and B’s down to “junk bonds”.  The less risk and higher the rating the lower the interest rate.