FORGET THOSE HOT STOCK TIPS, AT LEAST FOR NOW. NONE OF THEM WILL DO ANY GOOD WITHOUT A PROPER FINANCIAL FOUNDATION.

BY JOSEPH PAWLIKOWSKI

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TYPES OF INVESTMENTS
Now that you understand the basics of financial planning and the risks involved with investing, it’s time to prime yourself in the types of investments available. No one is necessarily better than the other, as each serves its own purpose. Understanding the nature of them will give you a better idea of what best fits your long- and short-term goals.

STOCKS
When people hear the words “investment” and “broker,” the stock market is usually the first thing that comes to mind. When a company goes public, it is divided into a certain number of shares. Some of these shares are disbursed among the Board members; the rest is put on the stock market for public sale. Each share, in essence, means you own 1/x of the company, where x is the total number of shares.

Perhaps the most important factor when deciding whether to invest in a particular stock is the company’s value relative to the asking price. Instead of asking, “is this a good company?” you should be asking, “is this a good company at this price?” Regression to the mean is a consideration in the stock market, meaning that over-performing companies will eventually come down to earth, and under-performing companies stand a chance to recover. Company X may be a good company that projects well for the future, but if it is overvalued, it is not a good buy.

A common misconception in the stock market is that you can buy and sell a stock for the exact price listed on the ticker. True, that is the approximate price of the stock at the time you put in your purchase, but that may not be the exact price when the sale is consummated.

Placing an order for 100 shares of Company X is just the beginning of the process. Your broker then calls his floor trader at the appropriate market, who will find another floor trader willing to sell 100 shares of Company X. This sounds like it may take a while to find a match, but floor traders generally know which traders make deals with particular stocks. The two then agree on a price, at which time your broker will notify you of the final sale price.

BONDS
When buying a corporate bond, you are essentially lending money to a company. You do not own stake in the company as with stocks, so you do not benefit if the stock price rises. Instead, the company pays interest until the maturity date, which is specified at the time of purchase. The interest earned from bonds is taxable.

Bonds are generally a safe investment because the interest rate does not fluctuate, and you are promised a return of the principal. The risk involved is that a company may default on the bond, meaning that they are not able to make the interest payment. This is not much of an issue when purchasing a bond from a blue chip corporation. However, the interest rate will not be high.

Smaller, lesser known companies usually offer higher interest rates that come with a greater risk of default. Companies generally offer a higher interest rate on bonds in order to attract more investors. Michael Milken made these high-risk, high-reward bonds (known as junk bonds) famous in the 1980s, using them to leverage takeovers of larger companies.

MUTUAL FUNDS
Maintaining a diversified portfolio is said to be of the utmost importance. For some people, though, it’s difficult to keep up with the activity of various stocks. A broker can handle the day-today operations of your portfolio, but most people want more control over their money. Mutual funds take care of diversification for you.

The most common mutual funds, stock funds, are a diverse collection of stocks. There are two ways in which stock funds can make money for their investors. First is through the increase in value of the fund’s stocks. Sometimes, though, the fund will pay a dividend or interest as the return on investment.

Another type of mutual fund is a bond fund, which carries diverse bonds instead of diverse stocks. This is considered a safer investment on the whole, but there are still risks. If, for instance, a bond carried by the fund is traded before maturity, it loses value, which is levied directly on the investors. Bond fund holders also run the risk of a company defaulting on a bond.

Money market funds are short-term investments, usually maturing in under 13 months. Like bond and stock funds, money market funds are collections of securities. However, all of these securities have short maturity periods, meaning you will see the return on your investment soon after putting in the money. The major risk in money market funds is that they are not insured by the United States government.

CDS
Certificate of Deposits, or CDs, are similar in nature to bonds. Generally, a CD will pay a higher rate of interest than a savings account. The catch is that the money must remain in the CD until a pre-specified maturity date, lest the investor pays an early withdrawal penalty.

A CD typically pays a fixed interest rate until the maturity date, though variable rate CDs have become more common of late. The risk assumed in CD investment is a change in interest rates. While an investor benefits from a drop in interest rates, he or she will lose out if the interest rates rise.

To offset losses incurred by lowered interest rates, most banks issue “call” features on CDs. A call is a period of time set when the investment is made, after which the issuing bank can pay out the CD amount plus accrued interest and terminate the agreement. This is not a reciprocate function, as an investor may not call a CD if interest rates rise. Before investing in a CD, you should inquire about the maturity date and call option.

IRAS
There are two types of Individual Retirement Accounts, or IRAs: Traditional and Roth. Both are low-risk saving tools for retirement, and offer tax benefits. There is a yearly
contribution limit to an IRA, which is currently $5,000. After the age of 50, this number jumps to $6,000. Typically, IRAs cannot be cashed out until age 59 1/2, with a 10 percent penalty incurred for early withdrawal.

Traditional IRAs allow you to allocate pre-tax dollars to the fund. If, for example, you make $100,000 in a given year and invest the maximum $5,000 in a Traditional IRA, your tax bill will be based on total income of $95,000.

Once you begin receiving payments from the IRA, however, the money will be taxed as normal income. Participation in an employee 401(k) plan by you or your spouse may preclude you from using pre-tax dollars for your IRA. This is a circumstance dependent on income. An IRA representative will be able to answer questions regarding taxation.

The main difference in a Roth IRA is that post-tax money is invested. However, when you begin withdrawing from the account, it is tax-free, since the tax has already been paid. You do not pay taxes on the interest gained from a Roth IRA, which makes it a very attractive option. The restriction on this type of IRA is that your adjusted gross income must be below $110,000 if you are single, $160,000 if filing jointly. Once your income exceeds these levels, you may no longer contribute to a Roth IRA.

REVERSE MORTGAGES
An increasingly popular form of income for retired peoples is a reverse mortgage. Put simply, a reverse mortgage is a loan based on the equity of your home. There is no interest on the loan, and is repaid upon death or when you move.

A more detailed explanation of reverse mortgages can be found at http://www.unioncountyvoice.com/2005-09/personalfinanceoutlook.htm For a free budget planning guide, visit our Web site here.

Information from this report was obtained from the United States Securities and Exchange Commission, http://www.sec.gov.

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