Browsing the financial headlines often turns up one recurring word: Securities.
Reading or hearing that term can feel like, “Um, what’s that?” But the truth is you probably already know what securities are. You just didn’t know they were called securities.
So what is a security? The quick (albeit confusing) answer: “It’s a stock ... it’s a bond … well, actually, it’s both.”
In the pre-digital age, before the days of virtual trading and buying stocks using a smart app on your touchscreen phone, investors would receive paper certificates that served as proof of their investment. These certificates were called securities.
Nowadays, “security” is a catch-all term for many kinds of investments—stocks, bonds, mutual funds, etc. (One trick is to think of a security as an intangible investment. For example, if you buy gold bars, that’s not a security. But if you buy stock in a precious metal fund, that’s a security. Also, securities do not include tangible assets like a car or a home.)
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There are two types of securities—debt securities and equity securities. Debt securities are also called fixed-income securities, which include bonds and CDs. They are called debt securities because when we purchase a bond, the corporation or government entity that we buy it from is now in debt to us. (For more information about bonds check out our guide, Bonds 101.)
Equity securities, meanwhile, are commonly referred to as stocks. They are called stocks because you actually have a stake in the company.
Most debt and equity securities are liquid, which means that you can cash them out at any time. Liquidity is important because when you have reached your target goal and are ready to cash out of your investment, you may be able to do it right away, whereas with an asset like a house it may take several months to sell.
What are the Risks?
The question is not “Should I invest in securities?” But, rather: “What kind of securities should I purchase?” As a financial planner, I help my clients answer that question by asking them another in return: “How comfortable are you with risk?” A big part of my job is to help people assess their risk so that they can choose the right securities for their investment portfolios.
People who are comfortable taking more risk in their portfolio often invest in equity securities because they offer a potential higher rate of return over the long term, and with the potential of higher returns comes the inevitable higher risk, as growth is not guaranteed.
Meanwhile, people who want to take less risk in their portfolio invest in debt securities because they provide more stability in the form of lower fluctuating investments with a lower rate of return. Keep in mind, too, that fixed-income securities are not guaranteed investments and they can also lose value (though the risk of that happening tend to be lower than with equity securities).
When I’m helping a client build a portfolio, I often present them with this scenario: “Say you planned to invest $10,000 for five years, but after one year the value dropped to $9,000—would you panic and sell or would you hunker down?” I ask this because the types of securities you might choose would depend on whether you prefer to take the slow and steady route for your investment portfolio (in which case, you might invest a larger percentage in debt, or fixed-income, securities) or if you are more comfortable with larger fluctuations for a potential higher rate of return (in which case you might invest a larger percentage in equity securities).
The level of risk that comes with buying any kind of security also depends on the size and stability of the entity that you're buying into. For example, the risks of investing in a start-up company are a lot higher than investing in a well-known company with a stable history and proven past growth.
How to Shop for Securities
You can purchase securities through a full-service brokerage firm either online or in person through a local branch, or choose them on your own with a self-service broker.
As you begin to make your investments, remember that diversity is key. You’ve heard this advice before, but it’s worth repeating: Don’t put all your eggs in one basket. There's higher risk when you sink all your money into a single stock or a single bond. It's a smart investment strategy to diversify your investment portfolio through a variety of different debt and equity securities.
The name of the game is finding the perfect investment mix depending on your risk tolerance and time horizon. When you're ready to build a portfolio, a certified financial planner™ from LearnVest Planning Services can help.
LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc. that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment advice. Please consult a financial advisor for advice specific to your financial situation.