Knowing the different types of securities is important for anyone looking to build a well-balanced investment portfolio. By understanding these options, investors can choose investments that match their financial goals and comfort with risk.
Securities are financial instruments that hold some value and they come in several forms, each with its own unique features.
When most people hear about investing, they usually think of the common stocks. But there are many other securities traded on exchanges that can help investors meet higher goals and handle risk in their own way.
The 5 main types of securities include:
Each of these securities offers unique opportunities and risks, allowing investors to broaden and tailor their investment strategies more effectively than before.
Common stock gives investors a share of ownership in a company, often referred to as equity. By owning common stock, investors hold a small claim on the company’s assets and profits.
However, not all shares carry the same weight. For example, if a company goes bankrupt, common stockholders are usually the last to receive any remaining funds, which sometimes means they may not get paid at all also.
Share Classes: Companies may issue different classes of common stock, such as Class A or Class B. These classes can come with various rights, like the ability to vote at shareholder meetings or different levels of claim compared to other share classes.
Earning Potential: Investors can benefit if the stock price goes up or through dividends when the company decides to share its profits.
Speculative Nature: Investing in common stock can be risky, especially with companies that are working on new products or technologies. While there is potential for high returns, there is also a higher chance of risks or losses.
Market Fluctuations: Even strong companies can see their stock prices fall due to problems in their industry or broader economic issues. It is important to remember that just because a stock performed well in the past does not mean it will do so in the future as well.
Preferred stock is another type of ownership in a company that gives shareholders certain advantages over common stockholders. In most cases, preferred shareholders have a higher claim on the company’s assets and earnings than common stock holders.
One main feature of preferred stock is that it generally pays a fixed dividend, which is distributed before any dividends go to common shareholders. However, preferred stockholders usually do not have any voting rights in the company.
Fixed Dividends: Preferred shareholders receive dividends at a predefined rate, offering a regular income stream that is often more reliable than the dividends from common stock.
Priority in Liquidation: If the company goes through liquidation, preferred shareholders are paid before common stockholders. However, they still stand behind bond holders when it comes to claims on the company’s assets.
Limited Growth Potential: While preferred stock provides stable dividends, its price usually doesn’t rise as much as common stock, which means there is very less potential for capital gains.
No Voting Rights: Unlike common shareholders, preferred shareholders generally do not have the right to vote on company matters, which limits their say in how the business run.
Exchange-Traded Funds or ETFs, are investment funds that you can buy and sell on stock exchanges, just like individual stocks. These funds hold a mix of assets, which might include stocks, bonds or commodities.
ETFs also use a system that helps keep their trading price close to the value of the assets they hold, known as the Net Asset Value (NAV).
Diversification: It allows investors to gain exposure to a wide range of assets with a single investment. This makes it easier to build a diversified portfolio without having to buy each asset separately.
Liquidity: Since ETFs trade on exchanges like regular stocks, investors can buy and sell them throughout the trading day at market prices.
Management Fees: ETFs usually have lower management fees than mutual funds, but these costs still reduce overall returns over time.
Market Movement: The price of an ETF can go up or down with the market. Moreover, it might not always match the performance of the index or assets they are designed to track exactly.
Real Estate Investment Trusts or REITs, are companies that own, manage or finance properties that generate income. They give investors a way to invest in large real- estate projects without having to buy or maintain properties by themselves.
Regular Income: By law, REITs must pay out at least 90% of their taxable income to shareholders as dividends. This makes them a popular choice for investors seeking reliable income.
Diversification: REITs let investors add real estate to their portfolios without directly owning physical property, helping to spread risk across different types of assets.
Interest Rate Impact: REITs can be affected by changes in interest rates. Higher rates can increase the borrowing costs, which may reduce their profits.
Market Volatility: Like other publicly traded investments, REITs can experience price swings due to changes in the overall market or economy.
American Depositary Receipts or ADRs, are certificates issued by U.S. banks that represent shares in a foreign company. They allow investors in the U.S. to invest in international companies without having to trade directly on overseas stock markets.
Easy Access to Foreign Companies: ADRs give U.S. investors a direct way to buy shares of companies based in other countries, all through U.S. exchanges.
Traded in U.S. Dollars: ADRs are priced and traded in U.S. dollars, making it easier to buy and sell them without worrying about converting currencies.
Regulated by U.S. Standards: Since ADRs are traded in the U.S., they fall under U.S. regulations, offering a level of transparency that direct foreign investments might not provide.
Currency and Political Risks: Even though ADRs trade in U.S. dollars, they still represent foreign companies. This means their value can be affected by changes in currency exchange rates and political events in the company’s home country, wherever it is.
Dividend Taxes: Dividends paid on ADRs might be reduced by foreign taxes before they reach investors, which can impact the income received.
When building a portfolio, it is important to choose the right securities that match your personal financial needs and ability to handle risk.
Here are some main points to consider:
Investment Goals: Think about what you want to achieve. Are you aiming for long-term growth, regular income, or simply looking to spread your investments across different areas?
Risk Tolerance: Each type of security comes with its own level of risk. For example, steady dividend-paying stocks tend to be less risky than international investments, which can be more unpredictable.
Liquidity Needs: Some investments, like ETFs, are easy to buy and sell throughout the day. Therefore, others such as MLPs, may have restrictions that make them harder to trade quickly.
Tax Impact: Knowing how different investments are taxed can help you plan more effectively and potentially keep more of your returns.
A well-rounded portfolio usually includes a mix of different types of securities. This helps balance the risks with the opportunity for returns, making it easier to stay on track with your financial goals.