Investment securities are investments purchased for generating revenue over the long term by banks or individuals. They differ from securities bought with the intent to sell within a short period. The main objective of buying investment securities is to provide a source of income through price escalation or payments.
Investment Securities – Investing for the Long-Term Provides Many Opportunities
Multiple types of securities can be held for the long term. Two of the most popular categories include equity securities and debt securities. Within these areas, other categories exist, such as growth or value stocks and corporate or government bonds. Here are some brief breakdowns of the types of equity securities and debt securities that can be purchased as well as the risks in doing so.
Equity securities are financial instruments representing ownership shares in a corporation. Typical equity securities include common stocks. They usually yield a higher rate of return over the long term than debt securities. However, if liquidation occurs with a company, a common stock shareholder will be paid last after bondholders and preferred shareholders.
The intent of purchasing equity securities can be for value or growth. Holding a diversified portfolio of both is often done, depending on the risk tolerance of the entity or person holding them. Banks will usually purchase common stock shares that pay steady dividends due to their low-risk tolerance. These specific investment securities are traditionally less volatile than growth stocks. A lower return is the trade-off for owning equity with lower risk.
Bonds, Common Stock and Preferred Shares
When a person is young, taking on more risk over the long term can be a good idea as it will likely generate higher gains. However, for older individuals who are nearing retirement, choosing value stocks that focus on paying dividends may be the best choice. In this scenario, choosing investment securities that are less risky, such as bonds, may also be advisable, depending on the risk tolerance of the entity or person making the purchase.
Common stock shares are traded through stock markets like the New York Stock Exchange and NASDAQ. The U.S. Securities and Exchange Commission oversees and regulates these markets.
Another type of equity security is a preferred share. Companies issue two types of shares, which are known as common and preferred. Holders of common shares in a company may or may not be entitled to receive a dividend. Even if a company is profitable, a dividend may not be given. In contrast, preferred shares may also be issued by a company. Investors who buy shares of preferred stock have the first claim on any dividends being paid. If the company makes money and pays a dividend, preferred stock shareholders will receive payment first.
Debt securities are debt instruments purchased to generate income via specific terms. They will typically have an interest rate and maturity date. Examples of these investment securities include corporate, government, and municipal bonds. In the case of corporate bonds, they are backed by the collateral of the company issuing them, reducing risk. If the terms of a corporate bond aren’t paid, a bank could seize the collateral, sell it and use the proceeds to recoup the debt.
The major risk of purchasing debt securities is credit risk, which is the probability of the borrower defaulting on their debt obligations. The government provides U.S. Treasury bonds (T-bonds). These are often touted as risk-free. The collapse of the United States government would probably have to occur for an investor to not get paid and lose the principal invested when T-bonds are owned. The U.S. government has an excellent credit rating and history of repaying the terms specified by the T-bonds they issue.
Corporate bonds offer many rewards and risks. The advantage of buying these investment securities is the regular cash payment that can be received. This element differs from common stock shares, which are typically purchased to make money off of price escalation and don’t pay any income in the form of dividends. Corporate bonds provide a higher certainty of income in this example. Bonds tend to be less volatile and less risky than stocks. For bond investments to succeed, a corporation needs to survive and pay its debt. In contrast, successful stock investments require a company to not only survive but grow its earnings consistently.
Rating agencies grade corporate bonds to help investors assess the risk of buying them. High-yield bonds, or junk bonds, can be purchased at the low end of the investment grading spectrum. While they may provide a higher yield, they are risky to buy due to the high odds of default or bankruptcy. Corporate bonds with lower risk will be rated AAA, AA, AAA or BBB. These types of bonds may not pay as much by the end of maturity but have excellent stability.
Mutual funds are available in several types. They are often created with a specific theme, which might include investing in particular sectors, such as gold or real estate. They can also be used to hold a portfolio of securities in companies with specific sizes, which can include small-cap, mid-cap or large-cap investments. In this example, purchasing mutual funds in a small-cap company might be done to generate higher gains as these investment securities are often more nimble than larger companies. They can take advantage of opportunities quicker, allowing them to grow the bottom line more rapidly than a larger company. When a small company completes this action, it can create a profitable boost in its price per share.
One of the main objectives of using mutual funds in an investment portfolio is to diversify risk. In an individual’s case, their risk tolerance will depend on their income, expenses and personal liabilities. A younger investor may have more risk tolerance and decide to invest in riskier securities, such as small-cap companies. Due to its diversification, doing so via a mutual fund is a safer way to invest. If one or two of the companies that are included in the mutual fund fail, the investor’s portfolio won’t be wiped out, which could happen if they purchase common shares in a single small-cap company.
One of the earliest forms of investment securities included gold. In ancient times, it was used as an alternative to money. Now, it can be purchased using mutual funds. The price of gold is determined by trading that is conducted 24/7. Supply and demand have a significant influence on the price of gold as well as market conditions. Economic and political conditions can influence the price swings of this equity.
Purchasing real estate for long-term capital growth is often done via mutual funds. These investment securities can be created by using a diversified portfolio of different property types. These can include residential, office, retail, self-storage, industrial and many other real estate types. A final portfolio will likely have several holdings and be under active management. This action is taken to ensure proper diversification and a return that matches the risk potential.
Investment Securities – Objectives
Having an investment objective when purchasing long-term securities is essential. If an individual or bank is looking for regular cash flow, utilizing bonds or dividend-paying securities may be best. In contrast, when the goal is to achieve gains based on how well a company can increase its profits, buying shares in growth stocks or those types of mutual funds may be the ideal choice.
Tolerance for Risk
Another important factor to consider when purchasing investment securities is risk tolerance. As discussed, different securities have higher and lower risk factors, making it critical to assess each financial instrument before buying. Investors with a higher risk appetite may want to own a portfolio with riskier investments, such as stocks or mutual funds in growth companies. An older individual with more to lose if their portfolio drops in value will probably be best suited to buy bonds carrying a specific interest rate or dividend-paying stocks. Banks will likely choose the latter as they must ensure their holdings are invested in safer securities.
Investment Securities – The Bottom Line
Investing in securities as a long-term hold can be done in many ways. This action will often depend on the options best fitting the goals for the investment objective. For weekly information on investment securities, stocks, crypto and more…sign up for one of our best investment newsletters. Join millions of others who have signed up and are now making smarter, more profitable investments.