| Don't run away! This is going to
be very simple. I've been an investment advisor
for a number of years now, and one of my pet
peeves is how some brokers and other "money
men" try to bury folks with fancy
terminology so they'll look smart and impress
their potential clients.
They bedazzle
you with talk of annuities, securities, zero
coupons, loads, mutuals, futures, options and the
like, but they never define the terms.
Let's strip all
away and distinguish between the two primary
types of investments before discussing the
packaging.
Generally,
investments fall into two classes: stocks and
bonds. Usually, these are sold through a broker
who is licensed to trade in investments and
operates under a federally insured program
similar to the FDIC program that insures your
bank account.
Stocks
When you buy
stocks, you buy a piece of a company; you become
an owner along with thousands of others who own
stock in this corporation. Ownership of the
company is divided into a specified number of shares,
and your stock certificate designates how many of
those shares you own. Normally, you don't receive
an actual certificate, but will receive a record
of your shares from your broker.
Because you own
part of the company, you share in the profits.
Payments of these profits to shareholders are
called dividends. If the company does not
make a profit, you get no dividends.
Most stocks are
publicly traded on a stock exchange such as the
New York Stock Exchange (NYSE) and brokerage
houses pay dearly for their seats (memberships)
on these exchanges.
As shares are
bought and sold, prices fluctuate many times each
hour. Your shares may increase in value over time
so that your investment returns are from growth
as well as earnings. Of course, your shares may
also lose value. There are no guarantees!
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Bonds
Bonds are loans.
When you buy a bond, you are loaning money to an
entity. If you buy a municipal bond, you are
lending to a community. When you buy a corporate
bond, a company is borrowing from you. You may
also loan money to the government buy purchasing
savings bonds, etc.
Because they are
loans, bonds earn interest, and that interest may
be paid in increments or saved up and paid out at
the maturity date of the bond.
Like stocks,
bonds are normally sold by a brokerage house who
"packages" them. Think of it this way:
suppose Acme, Inc. wants to borrow ten million
dollars. It can't very well contact investors all
over the country, so it has a bond issue prepared
and the broker sells enough bonds to fund the
loan. Many investors have participated and the
broker keeps track of it all.
The same is true
of mortgages. Banks lend you money to buy a home,
but to keep lending to other home buyers, they
need a constant influx of funds. So they sell the
mortgages to brokers who "package" them
as CMOs (Colateralized Mortgage Obligations) and
sell pieces of them to thousands of small
investors. If you buy a $5,000 CMO, you are
actually helping finance someone's home.
For more bond
information see The Bond Market Assn.
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