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Many investors choose to diversify their portfolio and invest in numerous types of investments to mitigate risk.
While mitigating risk is the main objective, there are some investors who choose to invest a portion of their investment portfolio in companies (and stocks) that have a larger potential for high returns.
Knowing how companies raise capital for growth and/or operational continuance gives investors knowledge into the different types of investments made available through companies.
Let's take a look at the different types of stocks available for investors.
Debt
Some companies choose to acquire debt (e.g., loans or lines of credit) as a means of funding growth or operational continuance. Many do not choose this route since the interest on such debt may be substantial and may not make good business sense. Nonetheless, the interest on such loans are deductible to the company, thus it may make sense in certain cases.
Loans acquired by companies may be from financial institutions such as banks, credit unions, and other sources. In the Self-Directed IRA world, individuals may use their retirement plans to issue notes to companies looking for that capitalization boost.
Bonds
Bonds are considered a form of debt, though they are more like loans or an IOUs. The only difference is that you loan your money to an entity and they promise to pay you back in full.
Investors enjoy the safety of bonds and their steady stream of income when the stock market becomes unpredictable. Some companies choose to sell bonds because they have a guaranteed rate of return for the investor and may be secured or non-secured.
Bonds that yield a higher rate of return receive a higher rating since it could produce a quicker return on investment and lower the amount of risk.
Stocks
Many companies choose to issue stock certificates which allow the investor a level of ownership with the company.
There are two types of stocks a company may choose to issue: preferred and common stocks.
1) Common Stocks
Common stocks are issued certificates of ownership to investors. The value of the certificate grows in-line with the growth of the company. The decline of the investment is also in-line with the decline of a company. Each individual investor has voting rights regarding matters company matters.
The company may choose not to pay for common stocks, or even pay dividends to common stock holders. If the company fails, common stock holders are the last to get paid in comparison to bonds and preferred stock holders.
2) Preferred Stocks
Preferred stocks are issued certificates of ownership to investors that have guaranteed dividend payments to the investor (usually based on a certain percentage). Most often, preferred stocks are considered a fixed investment vehicle due to the guaranteed dividend. Most companies only issue a small percentage of this investment class to investors.
With the characteristics of company ownership and guaranteed dividends, an industry description of this type of stock is a hybrid stock, comparable to a bond and common stock. One main difference between common stocks and preferred stocks is voting rights. Preferred stock holders do not have voting rights, and their stock can eventually be converted into common stock shares at a prearranged price.
Also, if the preferred stock holder decides to sell the preferred stock shares, the company may buy back the shares. With the guaranteed dividends paid by preferred stocks, investment appreciation appears higher in comparison to common stock.
When retirement plan holders use their retirement plan assets to invest in stocks, bonds or notes, items like appreciation, dividends and interest earnings are tax-deferred. The earnings are not taxed until distributed. This allows for the interest and dividends to be reinvested for potentially greater investment appreciation.
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Entrust does not provide tax and advice. It is highly recommended to seek the assistance of a tax or legal advisor before entering into any investment transaction.
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