Types of Investments
A bond is a debt security, similar to an IOU. Borrowers issue bonds to raise money from investors willing to lend them money for a certain amount of time. When you buy a bond, you are lending to the issuer, which may be a government, municipality, or corporation. In return, the issuer promises to pay you a specified rate of interest during the life of the bond and to repay the principal, also known as face value or par value of the bond, when it “matures,” or comes due after a set period of time.
Investors buy bonds because:
- They provide a predictable income stream. Typically, bonds pay interest twice a year.
- If the bonds are held to maturity, bondholders get back the entire principal, so bonds are a way to preserve capital while investing.
- Bonds can help offset exposure to more volatile stock holdings.
Companies, governments and municipalities issue bonds to get money for various things, which may include:
- Providing operating cash flow
- Financing debt
- Funding capital investments in schools, highways, hospitals, and other projects
There are three main types of bonds:
- Corporate bonds are debt securities issued by private and public corporations.
- Investment-grade. These bonds have a higher credit rating, implying less credit risk, than high-yield corporate bonds.
- High-yield. These bonds have a lower credit rating, implying higher credit risk, than investment-grade bonds and, therefore, offer higher interest rates in return for the increased risk.
- Municipal bonds, called “munis,” are debt securities issued by states, cities, counties and other government entities. Types of “munis” include:
- General obligation bonds. These bonds are not secured by any assets; instead, they are backed by the “full faith and credit” of the issuer, which has the power to tax residents to pay bondholders.
- Revenue bonds. Instead of taxes, these bonds are backed by revenues from a specific project or source, such as highway tolls or lease fees. Some revenue bonds are “non-recourse,” meaning that if the revenue stream dries up, the bondholders do not have a claim on the underlying revenue source.
- Conduit bonds. Governments sometimes issue municipal bonds on behalf of private entities such as non-profit colleges or hospitals. These “conduit” borrowers typically agree to repay the issuer, who pays the interest and principal on the bonds. If the conduit borrower fails to make a payment, the issuer usually is not required to pay the bondholders.
- U.S. Treasuries are issued by the U.S. Department of the Treasury on behalf of the federal government. They carry the full faith and credit of the U.S. government, making them a safe and popular investment. Types of U.S. Treasury debt include:
- Treasury Bills. Short-term securities maturing in a few days to 52 weeks
- Notes. Longer-term securities maturing within ten years
- Bonds. Long-term securities that typically mature in 30 years and pay interest every six months
- TIPS. Treasury Inflation-Protected Securities are notes and bonds whose principal is adjusted based on changes in the Consumer Price Index. TIPS pay interest every six months and are issued with maturities of five, ten, and 30 years.
Bonds can provide a means of preserving capital and earning a predictable return. Bond investments provide steady streams of income from interest payments prior to maturity. The interest from municipal bonds generally is exempt from federal income tax and also may be exempt from state and local taxes for residents in the states where the bond is issued.
As with any investment, bonds have risks. These risks include:
- Credit risk. The issuer may fail to timely make interest or principal payments and thus default on its bonds.
- Interest rate risk. Interest rate changes can affect a bond’s value. If bonds are held to maturity the investor will receive the face value, plus interest. If sold before maturity, the bond may be worth more or less than the face value. Rising interest rates will make newly issued bonds more appealing to investors because the newer bonds will have a higher rate of interest than older ones. To sell an older bond with a lower interest rate, you might have to sell it at a discount.
- Inflation risk. Inflation is a general upward movement in prices. Inflation reduces purchasing power, which is a risk for investors receiving a fixed rate of interest.
- Liquidity risk. This refers to the risk that investors won’t find a market for the bond, potentially preventing them from buying or selling when they want.
- Call risk. The possibility that a bond issuer retires a bond before its maturity date, something an issuer might do if interest rates decline, much like a homeowner might refinance a mortgage to benefit from lower interest rates.
A certificate of deposit (CD) is a savings account that holds a fixed amount of money for a fixed period of time, such as six months, one year, or five years, and in exchange, the issuing bank pays interest. When you cash in or redeem your CD, you receive the money you originally invested plus any interest. Certificates of deposit are considered to be one of the safest savings options. A CD bought through a federally insured bank is insured up to $250,000. The $250,000 insurance covers all accounts in your name at the same bank, not each CD or account you have at the bank.
As with all investments, there are benefits and risks associated with CDs. The disclosure statement should outline the interest rate on the CD and say if the rate is fixed or variable. It also should state when the bank pays interest on the CD, for example, monthly or semi-annually, and whether the interest payment will be made by check or by an electronic transfer of funds. The maturity date should be clearly stated, as should any penalties for the “early withdrawal” of the money in the CD. The risk with CDs is the risk that inflation will grow faster than your money, and lower your real returns over time.
Broker certificates of deposit
Although most CDs are purchased directly from banks, many brokerage firms and independent salespeople also offer CDs. These individuals and entities, known as “deposit brokers,” can sometimes negotiate a higher rate of interest for a CD by promising to bring a certain amount of deposits to the institution. The deposit broker can then offer these “brokered CDs” to their customers.
Thoroughly check out the background of the issuer or deposit broker to ensure that the CD is from a reputable institution. Deposit brokers are not licensed or certified, and no state or federal agency approves them. Since anyone can claim to be a deposit broker, always check whether the deposit broker or the company he or she works for has a history of complaints or fraud. Many deposit brokers are affiliated with investment professionals. You can check out their disciplinary history using the SEC’s and FINRA’s online databases. Your state securities regulator may have additional information. To research the background of deposit brokers who are not affiliated with an investment firm, start by contacting your state’s consumer protection office.
Commodity futures contracts are an agreement to buy or sell a specific quantity of a commodity at a specified price on a particular date in the future. Metals, grains, and other food, as well as financial instruments, including U.S. and foreign currencies, are traded in the futures market. With limited exceptions, trading in futures contracts must be executed on the floor of a commodity exchange. Exchange-traded commodity futures and options provide traders with contracts of a set unit size, a fixed expiration date, and centralized clearing. In centralized clearing, a clearing corporation acts as a single counterparty to every transaction and guarantees the completion and credit worthiness of all transactions.
Anyone who trades futures with the public or gives advice about futures trading must be registered with the National Futures Association (NFA). Before investing in commodity futures, check that the individual and firm are registered.
The SEC does not regulate commodity futures. The Commodity Futures Trading Commission (CFTC) is the federal agency that regulates futures trading. The CFTC cautions investors to be wary of offers for high yield investment opportunities in futures, options, or foreign exchange, also called forex. These are common areas of fraud.
Hedge funds pool money from investors and invest in securities or other types of investments with the goal of getting positive returns. Hedge funds are not regulated as heavily as mutual funds and generally have more leeway than mutual funds to pursue investments and strategies that may increase the risk of investment losses. Hedge funds are limited to wealthier investors who can afford the higher fees and risks of hedge fund investing, and institutional investors, including pension funds.
What should I know if I am considering investing in a hedge fund?
- Be an accredited investor. You generally must be an accredited investor, which means having a minimum level of income or assets, to invest in hedge funds.
- Read a fund’s prospectus and related materials. Make sure you understand the level of risk involved in the fund’s investment strategies, and that the risks are suitable to your personal investing goals, time horizons, and risk tolerance. As with any investment, the higher the potential returns, the higher the risks you must assume.
- Understand how fund assets are valued. Hedge funds may hold investments that are difficult to sell and may be difficult to value. You should understand the valuation process and know the extent to which a fund’s holdings are valued by independent sources.
- Understand fees. Fees impact your return on investment. Hedge funds typically charge an asset management fee of 1-2% of assets, plus a “performance fee” of 20% of the hedge fund’s profit. A performance fee could motivate a hedge fund manager to take greater risks in the hope of generating a larger return.
- Understand any limitations on your right to redeem your shares. Hedge funds typically limit opportunities to redeem, or cash in, your shares, to four times a year or less, and often impose a “lock-up” period of one year or more, during which you cannot cash in your shares.
- Research hedge fund managers. Make sure hedge fund managers are qualified to manage your money, and find out whether they have a disciplinary history within the securities industry.
Ask questions. You are entrusting your money to someone else. You should know where your money is going, who is managing it, how it is being invested, and how you can get it back. In addition, you may wish to read FINRA’s investor alert, which describes some of the risks of investing in funds of hedge funds.
When you invest in a private equity fund, you are investing in a fund managed by a private equity firm—the adviser. Similar to a mutual fund or hedge fund, a private equity fund is a pooled investment vehicle where the adviser pools together the money invested in the fund by all the investors and uses that money to make investments on behalf of the fund. Unlike mutual funds or hedge funds, however, private equity firms often focus on long-term investment opportunities in assets that take time to sell with an investment time horizon typically of 10 or more years.
A typical investment strategy undertaken by private equity funds is to take a controlling interest in an operating company or business—the portfolio company—and engage actively in the management and direction of the company or business in order to increase its value. Other private equity funds may specialize in making minority investments in fast-growing companies or startups.
Although a private equity fund may be advised by an adviser that is registered with the SEC, private equity funds themselves are not registered with the SEC. As a result, private equity funds are not subject to regular public disclosure requirements. Information about a private equity fund’s adviser that is registered with the SEC is available here.
A private equity fund is typically open only to accredited investors and qualified clients. Accredited investors and qualified clients include institutional investors, such as insurance companies, university endowments and pension funds, and high income and net worth individuals. The initial investment amount for a private equity investment is often very high.
Even if you are not invested in private equity funds directly, you may be indirectly invested in a private equity fund if you participate in a pension plan or own an insurance policy, for example. Pension plans and insurance companies may invest some portion of their large portfolios in private equity funds.
Because of their long-term investment horizon, an investment in a private equity fund is often illiquid and it may be necessary to hold an investment in a private equity fund for several years before any return is realized. Private equity funds typically impose limitations on investors’ ability to withdraw their investment. Investors in private equity funds should be able to wait the requisite time period before realizing their return. For an institutional investor, a private equity investment may represent only a small portion of its diversified investment portfolio.
Fees and expenses
When investing in a private equity fund, an investor usually receives offering documents detailing material information about the investment and enters into various agreements as a limited partner of the fund. These offering documents and agreements should disclose and govern the terms of the investor’s investment throughout the fund’s life, including the fees and expenses to be incurred by funds and their investors. The SEC has brought enforcement actions, for example here, involving fees and expenses that were incurred by funds and their investors without being adequately consented to or disclosed. Investors should be vigilant about the fees and expenses incurred in connection with their investment.
In addition, advisers may be managing multiple funds that are jointly invested in multiple portfolio companies. The adviser has a legal obligation to act in the best interests of each of the funds it manages and must allocate expenses among itself, its funds and the funds’ portfolio companies in accordance with this fiduciary duty. The SEC has brought several enforcement actions, for example here, related to shifting and allocation of expenses.
Virtual coins or tokens are created and disseminated using distributed ledger or blockchain technology. Recently promoters have been selling virtual coins or tokens in ICOs. Purchasers may use fiat currency (e.g., U.S. dollars) or virtual currencies to buy these virtual coins or tokens. Promoters may tell purchasers that the capital raised from the sales will be used to fund development of a digital platform, software, or other projects and that the virtual tokens or coins may be used to access the platform, use the software, or otherwise participate in the project. Some promoters and initial sellers may lead buyers of the virtual coins or tokens to expect a return on their investment or to participate in a share of the returns provided by the project. After they are issued, the virtual coins or tokens may be resold to others in a secondary market on virtual currency exchanges or other platforms.
Depending on the facts and circumstances of each individual ICO, the virtual coins or tokens that are offered or sold may be securities. If they are securities, the offer and sale of these virtual coins or tokens in an ICO are subject to the federal securities laws.
A blockchain is an electronic distributed ledger or list of entries – much like a stock ledger – that is maintained by various participants in a network of computers. Blockchains use cryptography to process and verify transactions on the ledger, providing comfort to users and potential users of the blockchain that entries are secure. Some examples of blockchain are the Bitcoin and Ethereum blockchains, which are used to create and track transactions in bitcoin and ether, respectively.
A virtual currency is a digital representation of value that can be digitally traded and functions as a medium of exchange, unit of account, or store of value. Virtual tokens or coins may represent other rights as well. Accordingly, in certain cases, the tokens or coins will be securities and may not be lawfully sold without registration with the SEC or pursuant to an exemption from registration.
A virtual currency exchange is a person or entity that exchanges virtual currency for fiat currency, funds, or other forms of virtual currency. Virtual currency exchanges typically charge fees for these services. Secondary market trading of virtual tokens or coins may also occur on an exchange. These exchanges may not be registered securities exchanges or alternative trading systems regulated under the federal securities laws. Accordingly, in purchasing and selling virtual coins and tokens, you may not have the same protections that would apply in the case of stocks listed on an exchange.
Virtual tokens or coins may be issued by a virtual organization or other capital raising entity. A virtual organization is an organization embodied in computer code and executed on a distributed ledger or blockchain. The code, often called a “smart contract,” serves to automate certain functions of the organization, which may include the issuance of certain virtual coins or tokens. The DAO, which was a decentralized autonomous organization, is an example of a virtual organization.
Depending on the facts and circumstances, the offering may involve the offer and sale of securities. If that is the case, the offer and sale of virtual coins or tokens must itself be registered with the SEC, or be performed pursuant to an exemption from registration. Before investing in an ICO, ask whether the virtual tokens or coins are securities and whether the persons selling them registered the offering with the SEC. A few things to keep in mind about registration:
If an offering is registered, you can find information (such as a registration statement or “Form S-1”) on SEC.gov through EDGAR.
If a promoter states that an offering is exempt from registration, and you are not an accredited investor, you should be very careful – most exemptions have net worth or income requirements.
Although ICOs are sometimes described as crowdfunding contracts, it is possible that they are not being offered and sold in compliance with the requirements of Regulation Crowdfunding or with the federal securities laws generally.
Ask what your money will be used for and what rights the virtual coin or token provides to you. The promoter should have a clear business plan that you can read and that you understand. The rights the token or coin entitles you to should be clearly laid out, often in a white paper or development roadmap. You should specifically ask about how and when you can get your money back in the event you wish to do so. For example, do you have a right to give the token or coin back to the company or to receive a refund? Or can you resell the coin or token? Are there any limitations on your ability to resell the coin or token?
If the virtual token or coin is a security, federal and state securities laws require investment professionals and their firms who offer, transact in, or advise on investments to be licensed or registered. You can visit Investor.gov to check the registration status and background of these investment professionals.
Ask whether the blockchain is open and public, whether the code has been published, and whether there has been an independent cybersecurity audit.
Fraudsters often use innovations and new technologies to perpetrate fraudulent investment schemes. Fraudsters may entice investors by touting an ICO investment “opportunity” as a way to get into this cutting-edge space, promising or guaranteeing high investment returns. Investors should always be suspicious of jargon-laden pitches, hard sells, and promises of outsized returns. Also, it is relatively easy for anyone to use blockchain technology to create an ICO that looks impressive, even though it might actually be a scam.
Virtual currency exchanges and other entities holding virtual currencies, virtual tokens or coins may be susceptible to fraud, technical glitches, hacks, or malware. Virtual tokens or virtual currency may be stolen by hackers.
Investing in an ICO may limit your recovery in the event of fraud or theft. While you may have rights under the federal securities laws, your ability to recover may be significantly limited.
If fraud or theft results in you or the organization that issued the virtual tokens or coins losing virtual tokens, virtual currency, or fiat currency, you may have limited recovery options. Third-party wallet services, payment processors, and virtual currency exchanges that play important roles in the use of virtual currencies may be located overseas or be operating unlawfully.
Law enforcement officials may face particular challenges when investigating ICOs and, as a result, investor remedies may be limited. These challenges include:
- Tracing money. Traditional financial institutions (such as banks) often are not involved with ICOs or virtual currency transactions, making it more difficult to follow the flow of money.
- International scope. ICOs and virtual currency transactions and users span the globe. Although the SEC regularly obtains information from abroad (such as through cross-border agreements), there may be restrictions on how the SEC can use the information and it may take more time to get the information. In some cases, the SEC may be unable to obtain information from persons or entities located overseas.
- No central authority. As there is no central authority that collects virtual currency user information, the SEC generally must rely on other sources for this type of information.
- Freezing or securing virtual currency. Law enforcement officials may have difficulty freezing or securing investor funds that are held in a virtual currency. Virtual currency wallets are encrypted and unlike money held in a bank or brokerage account, virtual currencies may not be held by a third-party custodian.
Be careful if you spot any of these potential warning signs of investment fraud.
- “Guaranteed” high investment returns. There is no such thing as guaranteed high investment returns. Be wary of anyone who promises that you will receive a high rate of return on your investment, with little or no risk.
- Unsolicited offers. An unsolicited sales pitch may be part of a fraudulent investment scheme. Exercise extreme caution if you receive an unsolicited communication—meaning you didn’t ask for it and don’t know the sender—about an investment opportunity.
- Sounds too good to be true. If the investment sounds too good to be true, it probably is. Remember that investments providing higher returns typically involve more risk.
- Pressure to buy RIGHT NOW. Fraudsters may try to create a false sense of urgency to get in on the investment. Take your time researching an investment opportunity before handing over your money.
- Unlicensed sellers. Many fraudulent investment schemes involve unlicensed individuals or unregistered firms. Check license and registration status on Investor.gov.
- No net worth or income requirements. The federal securities laws require securities offerings to be registered with the SEC unless an exemption from registration applies. Many registration exemptions require that investors are accredited investors; some others have investment limits. Be highly suspicious of private (i.e., unregistered) investment opportunities that do not ask about your net worth or income or whether investment limits apply.
The rise of Bitcoin and other virtual and digital currencies creates new concerns for investors. A new product, technology, or innovation – such as Bitcoin – has the potential to give rise both to frauds and high-risk investment opportunities. Potential investors can be easily enticed with the promise of high returns in a new investment space and also may be less skeptical when assessing something novel, new and cutting-edge.
Bitcoin has been described as a decentralized, peer-to-peer virtual currency that is used like money – it can be exchanged for traditional currencies such as the U.S. dollar, or used to purchase goods or services, usually online. Unlike traditional currencies, Bitcoin operates without central authority or banks and is not backed by any government.
IRS treats Bitcoin as property. The IRS recently issued guidance stating that it will treat virtual currencies, such as Bitcoin, as property for federal tax purposes. As a result, general tax principles that apply to property transactions apply to transactions using virtual currency
If you are thinking about investing in a Bitcoin-related opportunity, here are some things you should consider. Investments involving Bitcoin may have a heightened risk of fraud.
Innovations and new technologies are often used by fraudsters to perpetrate fraudulent investment schemes. Fraudsters may entice investors by touting a Bitcoin investment “opportunity” as a way to get into this cutting-edge space, promising or guaranteeing high investment returns. Investors may find these investment pitches hard to resist.
As with any investment, be careful if you spot any of these potential warning signs of investment fraud:
“Guaranteed” high investment returns. There is no such thing as guaranteed high investment returns. Be wary of anyone who promises that you will receive a high rate of return on your investment, with little or no risk.
Unsolicited offers. An unsolicited sales pitch may be part of a fraudulent investment scheme. Exercise extreme caution if you receive an unsolicited communication – meaning you didn’t ask for it and don’t know the sender – about an investment opportunity.
Unlicensed sellers. Federal and state securities laws require investment professionals and their firms who offer and sell investments to be licensed or registered. Many fraudulent investment schemes involve unlicensed individuals or unregistered firms. Check license and registration status by searching the SEC’s Investment Adviser Public Disclosure (IAPD) website or FINRA’s BrokerCheck website.
No net worth or income requirements. The federal securities laws require securities offerings to be registered with the SEC unless an exemption from registration applies. Most registration exemptions require that investors are accredited investors. Be highly suspicious of private (i.e., unregistered) investment opportunities that do not ask about your net worth or income.
Sounds too good to be true. If the investment sounds too good to be true, it probably is. Remember that investments providing higher returns typically involve more risk.
Pressure to buy RIGHT NOW. Fraudsters may try to create a false sense of urgency to get in on the investment. Take your time researching an investment opportunity before handing over your money.
Bitcoin users may be targets for fraudulent or high-risk investment schemes.
Both fraudsters and promoters of high-risk investment schemes may target Bitcoin users. The exchange rate of U.S. dollars to bitcoins has fluctuated dramatically since the first bitcoins were created. As the exchange rate of Bitcoin is significantly higher today, many early adopters of Bitcoin may have experienced an unexpected increase in wealth, making them attractive targets for fraudsters as well as promoters of high-risk investment opportunities.
Fraudsters target any group they think they can convince to trust them. Scam artists may take advantage of Bitcoin users’ vested interest in the success of Bitcoin to lure these users into Bitcoin-related investment schemes. The fraudsters may be (or pretend to be) Bitcoin users themselves. Similarly, promoters may find Bitcoin users to be a receptive audience for legitimate but high-risk investment opportunities. Fraudsters and promoters may solicit investors through forums and online sites frequented by members of the Bitcoin community.
Real estate investment trusts (“REITs”) allow individuals to invest in large-scale, income-producing real estate. A REIT is a company that owns and typically operates income-producing real estate or related assets. These may include office buildings, shopping malls, apartments, hotels, resorts, self-storage facilities, warehouses, and mortgages or loans. Unlike other real estate companies, a REIT does not develop real estate properties to resell them. Instead, a REIT buys and develops properties primarily to operate them as part of its own investment portfolio.
REITs provide a way for individual investors to earn a share of the income produced through commercial real estate ownership – without actually having to go out and buy commercial real estate.
Many REITs are registered with the SEC and are publicly traded on a stock exchange. These are known as publicly traded REITs. Others may be registered with the SEC but are not publicly traded. These are known as non- traded REITs (also known as non-exchange traded REITs). This is one of the most important distinctions among the various kinds of REITs. Before investing in a REIT, you should understand whether or not it is publicly traded, and how this could affect the benefits and risks to you.
REITs offer a way to include real estate in one’s investment portfolio. Additionally, some REITs may offer higher dividend yields than some other investments. But there are some risks, especially with non-exchange traded REITs. Because they do not trade on a stock exchange, non-traded REITs involve special risks:
- Lack of Liquidity: Non-traded REITs are illiquid investments. They generally cannot be sold readily on the open market. If you need to sell an asset to raise money quickly, you may not be able to do so with shares of a non-traded REIT.
- Share Value Transparency: While the market price of a publicly traded REIT is readily accessible, it can be difficult to determine the value of a share of a non-traded REIT. Non-traded REITs typically do not provide an estimate of their value per share until 18 months after their offering closes. This may be years after you have made your investment. As a result, for a significant time period you may be unable to assess the value of your non-traded REIT investment and its volatility.
- Distributions May Be Paid from Offering Proceeds and Borrowings: Investors may be attracted to non-traded REITs by their relatively high dividend yields compared to those of publicly traded REITs. Unlike publicly traded REITs, however, non-traded REITs frequently pay distributions in excess of their funds from operations. To do so, they may use offering proceeds and borrowings. This practice, which is typically not used by publicly traded REITs, reduces the value of the shares and the cash available to the company to purchase additional assets.
- Conflicts of Interest: Non-traded REITs typically have an external manager instead of their own employees. This can lead to potential conflicts of interests with shareholders. For example, the REIT may pay the external manager significant fees based on the amount of property acquisitions and assets under management. These fee incentives may not necessarily align with the interests of shareholders.
How to buy and sell REITs
You can invest in a publicly traded REIT, which is listed on a major stock exchange, by purchasing shares through a broker. You can purchase shares of a non-traded REIT through a broker that participates in the non-traded REIT’s offering. You can also purchase shares in a REIT mutual fund or REIT exchange-traded fund.
Understanding fees and taxes
Publicly traded REITs can be purchased through a broker. Generally, you can purchase the common stock, preferred stock, or debt security of a publicly traded REIT. Brokerage fees will apply.
Non-traded REITs are typically sold by a broker or financial adviser. Non-traded REITs generally have high up-front fees. Sales commissions and upfront offering fees usually total approximately 9 to 10 percent of the investment. These costs lower the value of the investment by a significant amount.
Special Tax Considerations
Most REITS pay out at least 100 percent of their taxable income to their shareholders. The shareholders of a REIT are responsible for paying taxes on the dividends and any capital gains they receive in connection with their investment in the REIT. Dividends paid by REITs generally are treated as ordinary income and are not entitled to the reduced tax rates on other types of corporate dividends. Consider consulting your tax adviser before investing in REITs.
Individual Retirement Accounts (IRA) provide tax advantages for retirement savings. You can contribute each year up to the maximum amount allowed by the Internal Revenue Service.
There are several types of IRAs available:
- Traditional IRA. Contributions typically are tax-deductible. You pay no taxes on IRA earnings until retirement, when withdrawals are taxed as income.
- Roth IRA. Contributions are made with after-tax funds and are not tax-deductible, but earnings and withdrawals are tax-free.
- SEP IRA. Allows an employer, typically a small business or self-employed individual, to make retirement plan contributions into a traditional IRA established in the employee’s name.
- SIMPLE IRA. Is available to small businesses that do not have any other retirement savings plan. The SIMPLE – which stands for Savings Incentive Match Plan for Employees – IRA allows employer and employee contributions, similar to a 401(k) plan, but with simpler, less costly administration, and lower contribution limits. Traditional and Roth 401(k) Plans
Individuals who want to save for retirement may have the option to invest in a 401(k) or Roth 401(k) plan. Both plans are named for the section of the U.S. income tax code that created them. Both plans offer tax advantages, either now or in the future.
With a traditional 401(k), you defer income taxes on contributions and earnings. With a Roth 401(k), your contributions are made after taxes and the tax benefit comes later: your earnings may be withdrawn tax-free in retirement.
A traditional 401(k) is an employer-sponsored plan that gives employees a choice of investment options. Employee contributions to a 401(k) plan and any earnings from the investments are tax-deferred. You pay the taxes on contributions and earnings when the savings are withdrawn. As a benefit to employees, some employers will match a portion of an employee’s 401(k) contributions. Income taxes on matching funds also are deferred until savings are withdrawn.
An employer-sponsored Roth 401(k) plan is similar to a traditional plan with one major exception. Contributions by employees are not tax-deferred but are made with after-tax dollars. Income earned on the account, from interest, dividends, or capital gains, is tax-free.
403(b) and 457(b) plans are tax-deferred retirement savings programs provided by certain employers. Employers such as public educational institutions (public schools, colleges and universities), certain non-profits, and churches or church-related organizations may offer 403(b) plans. Employers such as state and local government agencies and certain non-profit organizations may offer 457(b) plans. Some employers may offer both 403(b) and 457(b) plans, and allow you to contribute to both plans. Contact your employer to find out if both plans are available.
An employee stock ownership plan (ESOP) is a retirement plan in which an employer contributes its stock to the plan for the benefit of the company’s employees. This type of plan should not be confused with employee stock option plans, which give employees the right to buy their company’s stock at a set price after a certain period of time.
Similar to 401(k) plans, 403(b) and 457(b) plans allow you to contribute pre-tax money from your paycheck to your 403(b) or 457(b) plan to invest in certain investment products. These pre-tax contributions and their investment earnings will not be taxed until you withdraw the money, typically after you retire.
Social Security is a U.S. government program funded through payroll taxes on employees, employers, and self-employed individuals. The taxes are collected under authority of the Federal Insurance Contribution Act (FICA) and support Social Security programs, including Old-Age, Survivors, and Disability Insurance. Social Security helps not only older Americans, but also workers who become disabled and families in which a spouse or parent dies.
The Social Security Administration keeps track of your earnings throughout your working life. When you retire, the amount of your monthly Social Security benefit depends on your earnings and the age at which you retire. People who retire earlier typically receive lower benefit payments than they would if they postpone retirement.
The Social Security Administration has an online calculator at www.socialsecurity.gov/estimator that will provide immediate and personalized benefit estimates to help you plan for retirement. The Retirement Estimator is an interactive tool that allows the user to compare different retirement options.
You can open a my Social Security account at: www.socialsecurity.gov/myaccount that allows people quick, secure access to their personal Social Security information. You can use your my Social Security account to access your Social Security Statements, to check earnings, and get estimates of future Social Security benefits. If you already receive Social Security benefits, you can get a benefit verification letter, change your address and phone number, start or change direct deposit information, and get a get a Medicare replacement card or replacement form SSA-1099 or SSA-1042S for tax season.
Stocks are a type of security that gives stockholders a share of ownership in a company. Stocks also are called “equities.” Investors buy stocks for various reasons. Here are some of them:
- Capital appreciation, which occurs when a stock rises in price
- Dividend payments, which come when the company distributes some of its earnings to stockholders
- Ability to vote shares and influence the company
Companies issue stock to get money for various things, which may include:
- Paying off debt
- Launching new products
- Expanding into new markets or regions
- Enlarging facilities or building new ones
There are two main kinds of stocks, common stock and preferred stock. Common stock entitles owners to vote at shareholder meetings and receive dividends. Preferred stockholders usually don’t have voting rights but they receive dividend payments before common stockholders do, and have priority over common stockholders if the company goes bankrupt and its assets are liquidated. Common and preferred stocks may fall into one or more of the following categories:
- Growth stocks have earnings growing at a faster rate than the market average. They rarely pay dividends and investors buy them in the hope of capital appreciation. A start-up technology company is likely to be a growth stock.
- Income stocks pay dividends consistently. Investors buy them for the income they generate. An established utility company is likely to be an income stock.
- Value stocks have a low price-to-earnings (PE) ratio, meaning they are cheaper to buy than stocks with a higher PE. Value stocks may be growth or income stocks, and their low PE ratio may reflect the fact that they have fallen out of favor with investors for some reason. People buy value stocks in the hope that the market has overreacted and that the stock’s price will rebound.
- Blue-chip stocks are shares in large, well-known companies with a solid history of growth. They generally pay dividends.
Another way to categorize stocks is by the size of the company, as shown in its market capitalization. There are large-cap, mid-cap, and small-cap stocks. Shares in very small companies are sometimes called “microcap” stocks. The very lowest priced stocks are known as “penny stocks.” These companies may have little or no earnings. Penny stocks do not pay dividends and are highly speculative.
What are the benefits and risks of stocks?
Stocks offer investors the greatest potential for growth (capital appreciation) over the long haul. Investors willing to stick with stocks over long periods of time, say 15 years, generally have been rewarded with strong, positive returns. But stock prices move down as well as up. There’s no guarantee that the company whose stock you hold will grow and do well, so you can lose money you invest in stocks. If a company goes bankrupt and its assets are liquidated, common stockholders are the last in line to share in the proceeds. The company’s bondholders will be paid first, then holders of preferred stock. If you are a common stockholder, you get whatever is left, which may be nothing.
Even when companies aren’t in danger of failing, their stock price may fluctuate up or down. Large company stocks as a group, for example, have lost money on average about one out of every three years. If you have to sell shares on a day when the stock price is below the price you paid for the shares, you will lose money on the sale.
Market fluctuations can be unnerving to some investors. A stock’s price can be affected by factors inside the company, such as a faulty product, or by events the company has no control over, such as political or market events. Stocks usually are one part of an investor’s holdings. If you are young and saving for a long-term goal such as retirement, you may want to hold more stocks than bonds. Investors nearing or in retirement may want to hold more bonds than stocks.
The risks of stock holdings can be offset in part by investing in a number of different stocks. Investing in other kinds of assets that are not stocks, such as bonds, is another way to offset some of the risks of owning stocks.
You can buy and sell stocks through:
- A direct stock plan
- A dividend reinvestment plan
- A discount or full-service broker
- A stock fund
Direct stock plans. Some companies allow you to buy or sell their stock directly through them without using a broker. This saves on commissions, but you may have to pay other fees to the plan, including if you transfer shares to a broker to sell them. Some companies limit direct stock plans to employees of the company or existing shareholders. Some require minimum amounts for purchases or account levels.
Direct stock plans usually will not allow you to buy or sell shares at a specific market price or at a specific time. Instead, the company will buy or sell shares for the plan at set times — such as daily, weekly, or monthly — and at an average market price. Depending on the plan, you may be able to automate your purchases and have the cost deducted automatically from your savings account.
Dividend reinvestment plans. These plans allow you to buy more shares of a stock you already own by reinvesting dividend payments into the company. You must sign an agreement with the company to have this done. Check with the company or your brokerage firm to see if you will be charged for this service.
Discount or full-service broker. Brokers buy and sell shares for customers for a fee, known as a commission.
Stock funds are another way to buy stocks. These are a type of mutual fund that invests primarily in stocks. Depending on its investment objective and policies, a stock fund may concentrate on a particular type of stock, such as blue chips, large-cap value stocks, or mid-cap growth stocks. Stock funds are offered by investment companies and can be purchased directly from them or through a broker or adviser.
Buying and selling stocks entails fees. A direct stock plan or a dividend reinvestment plan may charge you a fee for that service. Brokers who buy and sell stocks for you charge a commission. A discount brokerage charges lower commissions than what you would pay at a full-service brokerage. But generally you have to research and choose investments by yourself. A full-service brokerage costs more, but the higher commissions pay for investment advice based on that firm’s research.