Investment Vehicles: Definition, Examples & Characteristics

Instructor: Shawn Grimsley

Shawn has a masters of public administration, JD, and a BA in political science.

How well you travel on the road to financial security often depends on the vehicles you are driving to get there. In this lesson, you'll learn about different types of investment vehicles and their key characteristics.

Investment Vehicles Defined

Bethany is a financial planner working with Charles, a new client. She is helping Charles develop a diversified portfolio of investments utilizing different investment vehicles that meet Charles' investment objectives and tolerance for risk. An investment vehicle is simply an investment product that is offered to investors that provide the chance for investors to earn a return, or profit, on the product purchased. Let's take a quick look at some of the major investment vehicles that Bethany can recommend to Charles.

CDs & Annuities

Two investment options that have limited risk of loss are certificates of deposit and annuities. If you invest in a certificate of deposit (CD), you give the bank money in return for a certificate that entitles you to earn a particular rate of interest payable at the end of the investment period. You are pretty much lending the bank your money. While it's possible to withdraw money from a CD, there will be penalties assessed. The maturity date of a CD varies; some may be cashed in without penalty in one month while others may not mature for years. CDs issued by your bank are insured by the Federal Deposit Insurance Corporation (FDIC) and are, therefore, safe so long as the CD and other accounts at the bank don't exceed the FDIC limits of $250,000. Charles will be taxed on the interest earned.

An annuity is a financial product, usually sold by an insurance company, that is structured to pay a regular income to its owner commencing upon a certain date, typically upon reaching retirement age. Charles will only be taxed on income generated by an annuity when he starts receiving payments or if he makes a withdrawal of funds from the annuity. Consequently, the value of the annuity grows quicker because the tax is deferred. Annuities may be fixed, which provides a fixed payment, or variable where the payments may be greater or lesser than a fixed annuity, depending on how well the investments with the annuity perform. Annuities are relatively low-risk investment vehicles, but that also means there's a lower potential return (i.e. profit).

Stocks & Bonds

Charles may also invest in stocks and bonds. A stock is a certificate representing an ownership interest in a corporation. Stocks are traded on various markets known as stock exchanges. Stocks can be categorized as either common stock or preferred stock. Holders of common stock may receive dividends, which is a distribution of profits from the company, and are entitled to vote at shareholder's meetings. On the other hand, holders of preferred stock get preferential treatment on payment of dividends and upon the distribution of the company's assets at liquidation over common stockholders. However, preferred stock usually does not come with voting rights.

Let's talk about taxes. Charles' income from dividends will generally be taxed in the year he receives them, and he'll also have to pay taxes on any gain from the sale of stock in the year he sells his shares. For example, if Charles bought 100 shares of AnyCorp, Inc. for $20 a share and sold them a few years later at $25 per share, he'd have to pay tax on the $500 gain (i.e., {(25-20) *100}).

While history tells us that stocks are probably one of the best, if not the best, investments for the long-run, prices can be quite volatile in the short-term, and investment in stocks do pose a substantial risk, especially if your portfolio of stocks is not diversified.

While stocks are about ownership, bonds are about debt. If Charles invests in bonds, he is basically loaning money to the entity offering the bonds. Bonds offered by the United States Government are known as treasury bonds, treasury notes, or treasury bills, depending on how long it takes before they mature. Bonds offered by state and local governments are known as municipal bonds. Municipal bonds are exempt from federal income tax and are usually exempt from most state and local taxes too. Bonds offered by companies are known as corporate bonds.

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