Investment Instruments

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There are many investment instruments available to the individual investor. The majority, however, are variations of just two investment types — debt and equity instruments.

Debt Instruments

Prices of debt instruments are primarily affected by interest rate movements. As interest rates rise, values of existing bonds fall; when interest rates fall, bond prices rise.

These investment instruments may preserve your principal and earn steady interest. They are most subject to purchasing power risk. Except for municipal bonds, all interest received is subject to federal, and usually state income tax.

• Savings accounts allow a depositor to save money and earn guaranteed interest at a low level of risk. Their major attraction is high liquidity; funds may be withdrawn at a moment’s notice. Most accounts carry federal insurance against loss of principal (up to $100,000 for each account), but their rates of return are often lower than competing instruments.
  
  
• Money market accounts are generally very safe accounts, and some provide an extra convenience of permitting check writing against the balance. However, some require a minimum balance in order to earn interest. Service or transaction fees can erode the return. Because of their composition and track record, they are generally considered to be very safe investments.
  
  
• Certificates of deposit (CDs) are issued by financial institutions in a range from 90 days to 10 years. When you buy a CD, you are lending money to the institution. For large deposits, long-term certificates, interest rates can be substantially higher than those paid on other deposit accounts. These are considered low risk investments, but not all CDs are federally insured. Rates for CDs are usually higher than money market accounts since funds are committed to a specific term; therefore, substantial penalties are charged for premature withdrawals.
  
  
• U.S. savings bonds represent your loan to the federal government, one of the safest investments you can make. They may not be sold or transferred to other investors, and the rates are nonnegotiable. Earnings from savings bonds are exempt from state and local income taxes, but not federal income taxes. However, purchases of savings bonds used for a dependent’s college tuition may qualify for exclusion from federal income taxes. Before purchasing, be sure of all the regulations and limitations since not everyone will benefit.

  In general, it is best to hold savings bonds until maturity when principal is repaid from a bond. If you sell them earlier, there will be a reduced return, or a penalty.

• U.S. Treasury bills (T-bills) are loans to the federal government. They may be held to maturity or sold to another investor. Generally, the longer the maturity, the higher the rate earned. All are exempt from state and local income taxes.



• Corporate bonds are debts of the corporation issuing the bonds. Because they have a higher risk than U.S. bonds, they pay higher yields. The yield will depend on factors including the financial health of the issuing company and on the prevailing market interest rate when they are first sold. Although some individuals hold bonds to maturity — locking in their returns — others sell them earlier. Premature selling presents both a risk and an opportunity. If market interest rates happen to be lower than the bond’s fixed yield, the bond’s value generally rises. Conversely, if inflation pushes prevailing rates higher, the bond’s fixed rate is no longer competitive — and the price of the bond is generally reduced. One way to potentially lessen this risk if you have a specific financial goal is to buy a bond that matures when that goal is due.

  The issuing company may fail, reducing the value of the bond either to zero or to a fraction of its face value. Although buying a bond of an established company might seem to present minimum risk, consider what might happen to the company over the life of the bond.

• Municipal bonds are IOUs of cities, states and government-like entities, such as public schools, airports, sewer or water authorities. To keep public tax costs low, these bonds are exempt from federal, state and local income taxes. Therefore, they generally are attractive investments for individuals in higher tax brackets. The risk and liquidity varies greatly from bond to bond, so be cautious before entering into such a purchase.