Becoming Investment Savvy (Pt. 2)
This is the follow up to our Investments 101.
Previously I wrote about stocks, bonds and mutual funds. Here we talk about the different types. There is a lot to cover, so I'll jump right in!
1. Money Market
Money market accounts can get confusing…
Typically, when you have your money in a bank, you receive very little interest for your checking account and only a slight bit more when you have your money in a savings account.
That is because a bank can hold your money and credit your account. They can then lend it out and charge interest on the loans.
They pay you some interest, cover all of their bank expenses, and the remainder is profit.
A money market account is practically the same as a checking account. You can write checks, access the money from ATMs, and get cash on demand from a bank.
The major difference being that financial institutions can invest in certificates of deposit (CDs), government securities, and commercial paper with the money from a money market account. Thus, they can have more stable and potentially higher returns.
They are typically tied to a brokerage investment account, but you can go to a bank and ask for a MM account. Oftentimes, the accounts have higher fees, minimum balances, and may have a maximum number of transfers per month.
2. CDs - Certificate of Deposit
These are usually issued from a bank. They have a timeline for them to hold onto your deposit in exchange for a guaranteed interest rate.
The timeline can range from a few months to years. The longer the timeline, the higher the interest rate.
The downside is that if you want access to the funds prior to the maturity date, then you will sacrifice the interest gained. You also have to pay long term capital gains tax. While not much, it does eat into your gain if you only receive a 2-3% return.
CDs are a good place to park your money if you want a little bit better return than your typical bank account or money market fund, but don't need to access the money for a while.
3. Corp. Bonds
Bonds have a "face value," which is the going rate for a bond. Typically it is set at $1000.
When a bond has 5% interest, the payments are 5% of the $1000 face value per year.
So, 5% paid quarterly would equal $12.50 every three months.
If you have more than one bond, the numbers adjust accordingly.
There are a few different types of corporate bonds that you can invest in.
Secured: They are backed by a collateral or secured against a physical object like property or real estate. Because they are secured, they may pay a lower rate.
Convertible: These bonds could be converted into a proportionate number of stocks of the entity. Say that you wrote a $100,000 check to a new company for convertible bonds. If the company hit some sort of unicorn status, then you could convert to the stock and that could pay out a lot more than the original note.
Guaranteed: These bonds are covered or honored by a third party. If company A cannot pay you for any reason, company B promises that they will. These are a little more risky because there isn't collateral, and you have to go off of the full faith and credit of each company.
With more risk comes higher payouts! These have a higher return rate than money market accounts or CDs.
4. Fed Gov’t Bonds
As mentioned above, bonds pay off of a face value. Sometimes the interest rates can rise or decrease, so the value of the bonds can change.
Think about it, if you just bought a bond for 5%, but now interest rates are 3%, what would it take to make you sell it? Someone would have to pay you more than face value to make it worth it, right?
The opposite holds true if interest rates rise. Will anyone want your 5% bond if rates are 10%? You'll have to sell it at a discount.
To mitigate some of the changes in interest rates and to make sure that businesses don't fail, some people invest in government bonds.
There are a multitude of ways to save and invest with the federal government. One of the most common is through bonds. The government uses the funds for its various purposes and then repays the bond holder.
Here are a few of the most common types of federal bonds:
Treasury-Bills: Mature in 4, 8, 13, 26 or 52 weeks.
Treasury-Notes: Mature between 2 years to 10 years.
Treasury-Bonds: Mature between 10 years to 30 years!
The longer the duration, the higher the interest rate paid.
There are more types of similar investments that have been repackaged in some way, but that's more of a 303 type of conversation. I've linked to Investopedia here.
STRIPS (Separate Trading of Registered Interest and Principal Securities)
CATS (Certificates of Accrual on Treasury Securities)
TIGRs (Treasury Investment Growth Receipts)
COUGRs (Certificate of Government Receipts)
GSE (Government Sponsored Entity)
5. State or Municipal Bonds
State or local governments can issue bonds as well. They function and operate in a very similar fashion to federal bonds. Here are a few callouts:
Municipal Bonds: Gains are tax-free at the federal level. Used for local endeavors.
General Obligation Bonds: Paid for by the jurisdiction's ability to tax. Think schools or prisons. There isn't any revenue coming out of those projects.
Revenue Bonds: These are when they build community centers, stadiums, etc. There will be cashflow coming from the project.
Hopefully that helps you understand some more jargon and lingo.
Look for Becoming Investment Savvy 303 in the future!
As always, remember to check out our website and social media to see what else is new!
About the author
Isaiah is a Certified Financial Education Professional TM and a dynamic speaker who loves to empower others. Isaiah has been married to his wife since 2012. At home they are joined by their four children and dog.