Client Education

Most people will find that their investment objectives change throughout their lives. Capital appreciation may be more important for the young investor, but once they enters their golden years, that same investor may place a greater emphasis on gaining income. Whatever your objective, knowing what investment options are out there is key.

Furthermore, having a well-diversified portfolio doesn’t necessarily mean just buying more than one stock; branching out into other areas of investment could be a viable alternative.

1. American Depository Receipt (ADR)

ADRs were first introduced in the United States in 1927. They represent a specific type of global depositary receipt (GDR) that was first issued in London and Luxembourg. A GDR represents a security that trades outside a company’s home country. In the case of an ADR, it represents a claim on a company based outside of the United States. The ADR represents a specified number of shares in a foreign corporation and represents a way for foreign firms to raise capital from U.S.-based investors. ADRs are bought and sold on U.S. stock markets just like regular stocks and are issued/sponsored in the U.S. by a bank or brokerage firm.

ADRs were introduced in response to the difficulty of buying shares from other countries which trade at different prices and currency values. U.S. banks simply purchase a large lot of shares from a foreign company, bundle the shares into groups and reissue them on a U.S.-based exchange. The depository bank sets the ratio of U.S. ADRs per home country share. This ratio can be anything less than or greater than 1. For example, a ratio of 4:1 means that one ADR share represents four shares in the foreign company.

There are several types of ADRs that foreign-based companies can utilize to gain a presence in U.S. markets. There is an option for the security to trade on an over-the-counter (OTC) exchange, which has less stringent requirements than on a listed exchange.

2. Annuities¹

Investors buy annuities from insurance companies to ensure they have enough income to live in retirement. An annuity represents a series of fixed-amount payments paid at regular intervals over time. An investor receives these payments in exchange for contributing a lump sum, upfront payment to the insurance company. Annuity contracts can last the entire life of the policy holder. Because of this, they offer protection against longevity, or outliving your investments. Payouts don’t generally increase because of inflation, but certain contracts do offer some inflation protection at an additional cost.

There are several types of annuities. Deferred annuities are just that – payments are deferred until a future date. In exchange for this deferral, payments in the future are likely to be higher than immediate annuities where payments start soon after an investor buys them for an upfront lump sum. Variable annuities combine insurance and investing where future payouts are based off how the underlying investments perform. These can be returns earned from index-based investments, such as the S&P 500, or even commodity-based indexes.

3. Bonds²

Bonds, or fixed income securities, are purchased at par (or face value), mature at fixed date in the future where the underlying investor receives his upfront investment back, and pay a set coupon rate. Essentially an investor is lending money to a corporation (or government entity) and in return receives income, and his or her money back at maturity.

Coupon payments are an obligation of the underlying company or borrower. If they are unable to make the payment at the agreed upon coupon dates (usually semi-annually, or every six months), the company can default and the bondholders can take control. It can lead to bankruptcy. Bonds have maturity dates out past one year.

4. Common Stock

Common stocks (or equity) represent ownership claims in publicly traded corporations. The ownership stake if a single share is incredibly small, especially for large companies such as Proctor & Gamble or General Electric, but common stock investors can claim ownership and call themselves shareholders. With ownership includes the ability to vote on company matters, such as approving members of the board of directors, choosing the annual auditor, or other items that come up in annual meetings.

Shareholders are also entitled to receive dividend payments, which are at the discretion of the board of directors. Unlike the income investors receive in bonds, which are obligations, dividend payments can be stopped without any liability on the part of the company. Of course, the share price can fall, but shareholders have no recourse.

5. Life Insurance

Individuals buy life insurance to provide a benefit to a spouse, children, or heirs (collectively known as beneficiaries) in case they die. The proceeds are known as a death benefit. For this potential benefit, the insured individual agrees to pay annual premiums.

Life insurance offers a similar benefit to other types of insurance. The pooling of individual risks in exchange for premiums allows an insurance company to pay benefits when they happen. The mix of premiums received where no benefit ends up being paid with those that are paid represents the pooled risk. Actuarial estimates of these two side of insurance leaves a reasonable profit as a benefit for the insurance firm’s shareholders, or policy holders in the case of a mutual insurance company where the policyholders are the underlying owners of the company.

There are a number of types of life insurance. Term life insurance is the most basic and offers life insurance for a set term of time, such as 10 or 20 years. Universal life insurance offers lifetime insurance and some flexibility on premium levels. Whole life insurance also offers lifetime insurance, but payments are more fixed. Both universal and whole life insurance can let the policy holder build up a cash value, or the option to cash out for some cash value should the original motivations for the insurance no longer hold.

6. Mutual Funds

Mutual funds have essentially brought investing to the masses. Mutual funds represent pools of funds from thousands, or even millions of investors. These funds are pooled into a single investment vehicle that has a ticker symbol and can be bought or sold on a daily basis.

Mutual funds come in a wide array of classes and asset mixes. Some invest purely in stocks where some manages look to outperform an underlying index (active funds) or others simply look to match an index (passive funds). Bond funds can pursue both, and some mix bonds and stocks to help investors outsource asset allocation selection. Nearly any type of security, including venture capital, real estate, private equity, or commodities can be put into a basket and offered as a mutual fund.

A closed-end fund is an investment fund that issues a fixed number of shares in an actively managed portfolio of securities. The shares are traded in the market just like stocks, but because closed-end funds represent a portfolio of securities they are very similar to an open-end mutual fund. Unlike an open-end mutual fund, the market price of the shares is determined by supply and demand and not by net asset value.

In addition to trading commissions, mutual funds charge expense ratios. Be sure to look up funds at Morningstar.com or related rating entities to fully investigate and research mutual fund strategies, expenses, and historical performance.

7. Exhcnage-Traded Funds (ETFs)³

ETFs represent an evolution from mutual funds. They have been around since approximately 1993 but have really grown popular in the past decade, or so. An ETF is similar to a mutual fund index fund in that it seeks to match the return of an underlying index. But it trades like a stock, or throughout the day for the same price as most stock commission rates. They are created by placing millions of shares into a commingled trust. In this respect, it is similar to a closed end mutual fund. An ETF can also be sold long or short and have related options attached to them.

8. Real Estate Investment Trusts (REITs)⁴

What if you want to invest in the real estate sector, but you either already have a house or don’t have enough money to buy one right now? The answer is REITs. REITs sell like stocks on the major exchanges and invest in real estate directly through properties or mortgages. A major advantage to REITs is that they receive special tax considerations. Furthermore, they typically offer investors high yields as well as a highly liquid method of investing in real estate.

There is a wide variety of REITs, but you can break it down into three main categories:

• Equity REITs – Equity REITs invest in and own properties (thus responsible for the equity or value of their real estate assets). Their revenues come principally from their properties’ rents.
• Mortgage REITs – Mortgage REITs deal in investment and ownership of property mortgages. These REITs loan money for mortgages to owners of real estate, or invest in (purchase) existing mortgages or mortgage-backed securities. Their revenues are generated primarily by the interest they earn on the mortgage loans.
• Hybrid REITs – Hybrid REITs combine the investment strategies of equity REITs and mortgage REITs by investing in both properties and mortgages

There are over 300 publicly-traded REITs operating in the United States whose average daily trading volume has more than quadrupled during the last three years, reaching over $280 million dollars. Dividend yields can reach as much as 9-12%.

9. U.S. Treasury Securities⁵

Also known as “government securities”, treasuries are a debt obligation of a national government. Because they are backed by the credit and taxing power of a country, they are regarded as having little or no risk of default. They are the definition of risk-free securities. Here is an overview Treasury securities, which differ by their maturity dates:

• Treasury Bills – A U.S. government debt security with a maturity of less than one year. T-bills do not pay a fixed interest rate. They are issued through a competitive bidding process at a discount from par.
• Treasury Notes – A marketable, fixed-interest rate U.S. government debt security with a maturity between one and 10 years.
• Treasury Bonds – A marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years. Treasury bonds are usually issued with a minimum denomination of $1,000.

The U.S. Treasury also issues Inflation-indexed Treasury Securities, or Treasury Inflation Protected Securities (TIPS). According to the Treasury, TIPS “provide protection against inflation. The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater.

TIPS pay interest twice a year, at a fixed rate. The rate is applied to the adjusted principal; so, like the principal, interest payments rise with inflation and fall with deflation.”

Source: Investopedia

1Annuity contracts have fees and expenses, limitations, exclusions, holding periods, termination provisions, and terms for keeping the annuity in force. Most annuities have surrender charges that are assessed if the contract owner surrenders the annuity. Qualified annuities are typically purchased with pre-tax money, so withdrawals are fully taxable as ordinary income, and withdrawals prior to age 59½ may be subject to a 10% penalty tax. Any guarantees are contingent on the claims-paying ability and financial strength of the issuing insurance company. It is important to understand that purchasing an annuity in an IRA or an employer-sponsored retirement plan provides no additional tax benefits other than what those provided through the tax-deferred retirement plan.

2In general, the bond market is volatile as prices rise when interest rates fall and vice versa. This effect is usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss. Bonds are also subject to other types of risks such as call, credit, liquidity, interest rate, and general market risks.

3Investing in mutual funds and ETFs involves risk, including the potential loss of principal invested. When redeemed, shares may be worth more or less than the original amount invested.

4An investment in a REIT involves a high degree of risk and is not suitable for all investors. Risk factors include but are not limited to: a lack of liquidity, limited transferability and share repurchase at a share price less than initially paid, variations in rental income, and changes in the value of the properties. There is no assurance that the investment objectives of a REIT will be attained.

5Treasuries are debt securities issued by the United States government and secured by its full faith and credit. Income from treasury securities is exempt from local and state taxes.