Investment Basics

Treasury bills are sold for less than their face value, but pay face value when they mature. For example, you might pay $970 for a T-bill worth $1,000 when it matures. The difference between what you pay and what the T-bill is worth is the interest.

You can buy Treasury bills in terms ranging from a few days to 26 weeks.

Companies sell shares of stock to raise funds, which are often used to grow the business. Stock represents ownership, also known as equity, in a company. When you buy shares of stock, you’re entitled to share in the company’s assets and earnings. You own a percentage of every dollar of that company’s profit or loss. The more shares you buy, the bigger your ownership interest becomes.

Advantages of stock

Many companies pay shareholders dividends – a portion of their profit – several times a year. You can also make money if you sell your shares when their price goes up.

The return on stocks is a combination of dividends and the profit from selling the stocks. Based on average rates of return over the last 100 years, stocks have the potential for a higher rate of return compared to other types of investments.

Disadvantages of stock

It can be hard to predict what stocks will do. A company could go bankrupt, leaving its stocks worthless. Stocks seldom completely lose their value, but price volatility means there is a risk to investing in stocks.

When you invest in a bond, you’re loaning money to a corporation (corporate bond) or a federal, state or local government (municipal bond). Governments use bonds to pay for their operations or for projects, such as hospitals, schools and power plants.

The bond issuer promises to pay back the initial principal when the bond matures, and to pay interest semiannually along the way. Bond prices are quoted as a percentage of the face amount ($1,000), so a price of 100 equals 100% of 1,000, or $1,000. A bond price quoted at 85 indicates a bond selling for 85% of $1,000, or $850. Amounts less than $10 are quoted in eighths. An eighth is equal to $1.25. A quote of 80 1/8 means a price of $801.25 ($800 + $1.25).

Advantages of bonds

• Tax-free. You don’t have to pay federal income taxes on your interest from most municipal bonds. They’re also free of state or local taxes in the state where they were issued. Corporate bonds are fully taxable, but they can pay higher interest rates than municipal bonds.
• Safe. Municipal bonds are considered relatively safe from default.
• Return. Bonds typically pay a better rate of return than a regular savings account.

Disadvantages of bonds

• Fixed interest rate. If interest rates go up before your bond matures, you’ll be stuck with the lower rate that you locked in when you purchased your bond. On the other hand, you’ll be better off if interest rates go down.
• Missed payments. If the issuer has financial problems, they may not be able to pay you interest. They also may not return the principal amount of the bond at maturity.
• Buy back. Issuers can buy back (or “call”) the bonds before maturity if interest rates fall. Be sure to study the call provisions thoroughly before buying a bond.

A mutual fund is a company that collects money from many people and invests it for them. Instead of buying individual stocks or bonds yourself, you buy shares of the mutual fund. This means you own a small piece of all the investments the fund holds, like stocks, bonds and other assets. A professional manager chooses these investments for the fund.

Mutual funds make it easy to spread your money across different investments (called diversification) and give you access to expert management. Most mutual funds let you start with a small amount of money, so even small investors can join. Some funds require a bigger initial investment, but you can often avoid that by setting up an automatic plan that moves money from your bank account to the fund every month.

You can invest in a mutual fund through a brokerage account or directly with the company that runs the fund.

Advantages of mutual funds

Mutual funds offer professional money management. The fund’s managers make day-to-day decisions about when and where to buy, which securities to hold and when to sell. It’s also easy to purchase and sell shares because they’re handled by the fund itself or through the stock market.

Disadvantages of mutual funds

Like many other investments, mutual funds don’t guarantee a return on your investment and may lose money. Mutual funds aren’t backed by the U.S. government.

Research potential risks before deciding on a mutual fund to buy. Look at its returns over the past three, five and 10 years. While past performance doesn’t indicate future results, it can give you a sense of the fund’s quality.

• Securities and Exchange Commission’s Investor.gov. This provides fund comparisons, investment education and warnings about scams.
• Financial Industry Regulatory Authority Fund Analyzer. Use this to compare fees, expenses and the value of mutual funds and exchange-traded funds.
• Thrift Savings Plan: The TSP website provides fund fact sheets and historical performance for federal and military retirement investments.

A mutual fund itself doesn’t pay taxes. Instead, when the fund earns income or makes a profit from selling investments, it passes that money to you and other shareholders. You are responsible for paying any taxes on what you receive.

These payouts, called dividends and capital gains, usually happen once a year, often in November or December. If you bought shares around that time, you might owe taxes for the year because of the timing.

Moving money between funds in the same fund family can also result in taxes. Even if the transfer is free, you might owe taxes on any gains from selling your old shares, or you might be able to claim a loss.

The fund will send you a 1099 form each year showing what you need to report if your account is taxable. Some dividends qualify for lower tax rates than regular income or short-term gains. Taxes can affect your overall returns, so be sure to talk to a tax professional for advice. The Defense Finance and Accounting Service will send you a tax statement.