There are three major types, or asset classes, of investments: cash and cash-equivalents, bonds, and stocks. These classes are generally discussed in terms of their risk, their return, (the amount they earn, which can be positive or negative), and the time horizon for the investment.
Cash and cash-equivalents
Cash and cash-equivalents are investments that can be readily turned into cash. Some examples are checking and savings accounts, bank certificate of deposits (CDs), and money market funds. These are also referred to as liquid investments.
- These types of investments typically maintain a stable value - that is, the principal doesn’t usually decrease - and they often earn a low rate of interest. Thus, they are low risk investments with a low potential return.
- If your goal is to protect the value of your investments or you have a short time horizon to meet your goal, the use of cash or cash-like investments may be a good fit.
Bonds are securities issued by governments or corporations when they need to raise funds, or capital. A bond has a maturity date, which is the date when the issuer must repay the face value of the bond to the investor. The issuer pays interest, usually at a fixed rate, during the time the bond is outstanding. Sometimes bonds are referred to as fixed income investments.
- The return earned by the investor on a bond is determined by the interest payments received and the gain or loss in the value of the bond during the time you own it.
The value of a bond changes over time due to:
- - The length of time until the bond matures
- - The interest rate paid by the bond, and
- - The interest rate in the market.
When interest rates in the market increase, the value of fixed rate bonds decline. When market interest rates decrease, the value of fixed rate bonds increase. In general, bonds with longer maturities have a more pronounced change in value when market rates change than bonds with shorter maturity.
- Bonds are often considered a moderate risk investment with moderate potential return.
- Bonds may be a good investment to use for goals with medium to long-term horizons and for those interested in taking only moderate risk.
Stocks are securities that represent ownership of a company. There are no contractual payments like there are for bonds. Return from stocks comes from dividend payments and/or the gain or loss in stock price. Some stocks pay dividends, providing an income stream; others provide return from gain or loss in value, and some have a combination of both.
- Stocks can have high fluctuations in value based on changes in economic and/or company conditions. Investments in stocks are generally more risky than investments in bonds, but the potential return is higher.
- Stocks are a good investment for financing your long-term goals.
- Historically, stocks have generated a higher return than other investments over time, despite the potentially large periodic fluctuations in value.
A mutual fund is an investment option that pools your money with other investors and is managed by investment professionals. These money managers use the pool of money to buy individual securities such as stocks, bonds, and cash investments. By purchasing many securities and investments in a range of asset classes, they are able to minimize the risk in the fund. Rather than owning the securities directly, you and the other mutual fund investors own shares in the mutual fund. You make money if the mutual fund shares grow in value or if the fund distributes profits to the investors.
Mutual funds are available with different investment goals and risk profiles.
- Conservative funds are managed to preserve the value of the securities. They generate lower returns, but have a low risk of loss.
- High growth/high income funds are more risky as they are managed to maximize value or income of the portfolio. While the potential return from these funds is higher than more conservative investments, there is a higher risk of loss of capital.
Tips & Resources - Stocks, Bonds and More
- While risk and expected return go hand in hand, the expected return is never guaranteed. In the long term, investments with the highest risk tend to have the highest potential returns. However, in the short term, the range, or volatility, of potential returns in a single time period is higher. For example, for the year 2013 stocks returned an approximately 30%, but in 2008, they returned approximately negative 37%.
- Investing in individual securities is a full-time job. For most investors, investing in mutual funds that match your risk profile and have professional fund managers choosing the individual investments is preferred.
- Be sure you understand the fee structure of the mutual funds. Investing in a fund that offers performance coupled with lower fees can add a significant amount to your savings over time.
- The website, Investor.gov, has information about specific types of investment products that fall within or invest in the three major asset classes. Go to Investor.gov for more information.
This material is for informational purposes only and is not intended as investment, tax, financial, legal or other advice. Your personal decisions should be based on the recommendations of your own professional advisors.
Unless otherwise noted, websites referenced herein that are outside the www.cpg.org domain are not associated with The Church Pension Fund and its affiliates (collectively, the Church Pension Group) and the Church Pension Group is not responsible for the content of any such websites.