Friday, 20 June 2008

Investment Building Blocks - Securities

Securities are the things an investor can buy. There is a mind-boggling array of securities available to a Canadian investor, but never fear, that potentially paralyzing complexity can be simplified.

Consider a food analogy. At the most basic level, there are ingredients - sugar, carrots, peas, beef, lamb etc which can be grouped into vegetables, meat and so on. Thus we have T-Bills, corporate bonds, government bonds, common and preferred stocks, grouped into categories - money market, fixed income and equities.

Those ingredients can then be bought one at a time or as products grouped and packaged in various ways, e.g. tomatoes by themselves or in a pasta sauce along with beef and perhaps sugar. You can thus buy shares of Bank of Montreal by themselves or within a mutual fund, combined with other stocks or with government bonds or both. Much of the confusing complexity arises from all the available combinations.

The chart shows common securities (i.e. it is not comprehensive). The rows are the basic securities and the columns are the product packages, ranging from an individual security to collective investment structures that combine many securities and many investors. The x's in the chart indicate roughly what can be bought in each product.

Basic Securities:
  • Money Market - you lend money short-term (days to a few months), to the government by buying T-Bills, or companies through commercial paper, and get back interest
  • Fixed Income - you lend money for years to governments or corporations by buying various types of bonds and get back interest payments plus your original investment, which may go up or down if you sell out before the bond maturity date (repayment date) - Details of GIC and CSB on InvestorEd
  • Equities - you buy part ownership in a company through shares and get back profits through dividend payouts or through appreciation of the shares as the company grows ... or not get any dividends and see the shares decline in value if the company does poorly. Details of Split-Share on Wikipedia
Product Packages:
  • Individual - you buy a bond or share of one government or company either directly or on a market
  • Mutual Fund - you buy units from the fund company itself (though usually you do so through a brokerage, agent or financial planner), which passes through any profits to you each year
  • Closed-end Fund has a fixed number of units, essentially shares, that are bought or sold on the stock market
  • Exchange Traded Fund (ETF) is, surprise, a fund that is traded on a stock exchange; unlike the closed-end fund has features that ensure the buy/sell price is very near what the stocks/bonds inside are worth
  • Income Trust - a corporate structure in which a company passes through all its profits to you the investor (on which you pay taxes, of course)
As you can see, there are many ways to satisfy your investing appetite!

Resources and Further Reading:
Shakespeare's Investment Primer
Gail Bebee's book No Hype: The Straight Goods On Investing Your Money

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