An investment is anything that you buy with the hope that it will become
more valuable over time. Stocks, bonds, your home, your collection
of perfectly preserved baseball cards, paintings, gold, silver —
even the cash you put in the bank — are all investments.
Liquid investments, or liquid assets, are those which can be converted
to money relatively quickly. The most common types of liquid
investments are bonds, stocks, mutual funds, and cash equivalents.
Let's explore each in some detail:
Bonds: Also called fixed-income securities, bonds are debt
instruments. The most common bonds are Treasury bonds (sold by the
U.S. government), municipal bonds (sold by municipal governments
including cities and school districts), and corporate bonds (sold by
companies). When a government or corporation sells a bond, they are
asking you, the investor, to loan them a certain amount of money, which
they will repay at a specified time with interest. When secured by
stable governments or companies, bonds are a relatively secure
investment, but the typical rate of return on a bond is relatively low
(compared to the potential rate of return on stocks, for example).
Stocks: Also called equities, stocks represent ownership of a
company. When you buy stock in a company, you become a shareholder
(a part owner) and are thus entitled to vote on certain company decisions
and receive dividends (returns on the company's profit) when the company
issues them (not all companies do). Stocks are most often a riskier
investment than bonds, but also tend to have higher rates of return.
Mutual funds: A mutual fund is a collection of investments,
most often stocks and bonds (though some mutual funds invest only in
real estate, cash equivalents, or commodities). When you purchase
shares of a mutual fund, you're pooling your money with other investors',
which enables you as a group to hire a professional manager to select
securities for the fund to invest in. Most mutual funds specialize
in a certain type of investment, such as large or small cap stocks,
government bonds, corporate bonds, stocks in certain industries, or
stocks in certain countries. The benefit of buying mutual fund
shares over buying individual stock shares is that a professional manager
chooses the securities to invest in, so that you don't have to choose
them and manage your portfolio yourself. Thus, you can keep your
day job and still be a successful investor.
Cash and cash equivalents: Certificates of deposit (CODs),
money markets, and bank deposits are all considered cash
equivalents. Often, these investments are highly liquid and quite
safe (some are even guaranteed by the FDIC), though they usually offer
the lowest rates of return of any investment type.
The most successful investors have some of their money invested in each
major type of investment — they diversify their portfolios.
Depending upon your stage in life (how close you are to retirement)
and your risk tolerance, you may have a greater or lesser percentage of
your money invested in stocks, bonds, or mutual funds. Most
investors invest only a small percentage (5-10%) of their portfolios in
cash and cash equivalents.