Account
Types and Investment Instruments
|
|
What Account Is Good For You?
Having decided upon the type of stockbroker you want you
now need to determine the type of account that is going
to meet your investment strategy:
Cash accounts
As the name suggests, a cash account is one into which you
need to deposit enough cash to cover your buy order. In
this regard, you broker will not execute the buy order until
you have sufficient cash in the account to cover the order.
Conversely, when you sell stock, your stockbroker will
deposit the sale proceeds into the cash account.
If you have a cash account you’ll need to familiarize
yourself with the T+3 rule. In short, the T+3 rule means
you have 3 days following a trade to make payment for that
trade; hence T+3.
|
Margin accounts
With a margin account you are effectively borrowing in order to
pay for the stocks you have just bought. With a margin account,
depending on your credit rating with your stockbroker, you can
borrow up to 50% of your purchase order. The remaining 50% you
are required to pay in the normal way.
Along with learning the T+3 rule, those who open a margin account
need to familiarize themselves with the margin call rule. A margin
call occurs when the stock you have bought drops to the level
where the stockbroker believes their investment is at risk. As
such, they issue you with a margin call, following which you are
required to either deposit more money into your account to lessen
their risk of loss or sell the stock immediately (taking the loss
with it). However, if the stock continues to fall, certain stockbrokers
will then issue a sell order, regardless of whether or not you
deposit money into the account to cover the broker’s position.
All-in-all, margin accounts can be used to make large profits.
However, it is also possible to lose vast sums of money very quickly
if you are not sure what you are doing with margin accounts.
Discretionary accounts
Again, as the name suggests, having a discretionary account means
your stockbroker is allowed to buy and sell stocks at their discretion
– without having to notify you beforehand of what they plan
to do.
Because of the blank authorization you give to your stockbroker
with a discretionary account, you really do need to trust them
implicitly and in most cases, unless the broker is a blood relative,
you’d do well avoiding this type of broking account.
Online trading accounts
In addition to the types of accounts above, these days it is also
possible to have an online trading account with a broker that
allows you to give buy and sell instructions via the internet.
In most cases, the broker also has internet capabilities and the
whole transaction is done electronically.
Day trading accounts
A current fad among stock market investors and traders is day
trading. In short, with day trading to buy and sell a stock on
the same day. At the end of the day you then total up your buys
and sales to see if you have made or lost money. However, because
of the risk associated with taking short-term positions in stock,
day trading should really be left until such time as you know
quiet a lot about stock markets, how they work, and how to make
money out of them.
The Different Types Of Investment Instruments
Having picked your stockbroker and opened your account, you are
now ready to proceed with your selected investment strategy. Basically,
although American corporations can only have their main stock
listed on one exchange, they are at liberty to issue different
types of securities, which they may list on different exchanges.
In this regard, common securities issued by American corporations
fall into two broad categories, (i) equity issues – or stocks;
and (ii) debt issues – widely known as bonds. In addition
to private American corporations issuing bond debt issues, the
US Treasury Department (and other agencies) also issue bond debt
issues. Thus, unlike equity issues, debt issues are not the exclusive
realm of corporations.
Each of these two broad categories can then be further broken
down into the following:
Equity 1 – Common Stock
A common stock represents the major type of stock that are listed
on US stock exchanges and which we trade in on a daily basis.
Along with the basic rights attached to the ownership of such
stock, such as the right to receive a dividend if the listed corporation
makes a profit and issues a dividend notice, stockholders are
also considered as being the ‘owners’ of the corporation.
As a result, they may vote at stockholders’ meeting to determine
the manner in which the corporation is going to be run (although,
in practice, this is usually done on the direction of the corporation’s
advisers; such as its accountant and directors).
Equity 2 – Preferred Stock
Contrary to its name, preferred stock has less rights attached
to it than common stock. However, the reason why it is called
‘preferred’, rather than ‘lesser’, is
because, in normal circumstances, a ‘preferred’ stockholder
will have a right to receive a dividend ahead of a common stockholder.
As such, the value of investing in preferred stock rests heavily
on the corporations ability to pay dividends in the future; because,
without the payment of dividends, the stock is only worth its
trading value (e.g. stockholders of preferred stock are unlikely
to be able to vote at stockholders’ meetings).
Debt 1 – US Treasury Bonds
From time-to-time the US Government’s expenditure exceeds
its tax revenues. In order to make up for the shortfall in this
income/expenditure, the government will issue what are known as:
- ‘Treasury Bonds’: with a maturity exceeding 10
years and in denominations ranging from $1,000 to $1,000,000
- ‘Treasury Notes’: with a maturity of between 2 and
10 years and are issued in denominations of $1,000
- ‘Treasury Bills’: short-term, i.e. less than 1 year,
maturity government issues. As the are issued for a short-term
period, strictly speaking they cannot be called ‘bond’
issues.
- ‘TIPS’ / ‘Treasury Inflation Protected Securities’:
with a maturity of 5, 10 or 20 years. The reason they are known
as ‘inflation protected’ is because the government
will adjust inflation figures every 6 months on the issue so that
the issue is protected against any rise or fall in national inflationary
figures.
As all of these bond types have the backing of the federal government,
they are widely considered the safest risk debt issue investment
you can make. Obviously, corresponding to low risk is low return.
Therefore, normally US Treasury Bonds have a very low interest
rate payable.
Beside the federal government issuing treasury bonds, other organizations
within the federal government can also issue debt instruments
to cover a short-term shortfall in their cash flow. Commonly these
are known as:
- Agency bonds;
- Municipal bonds.
Debt 2 – Corporate Bonds
Every known and then corporations in America need to undergo an
expansion program to stay competitive. To fund this expansion
program corporations can: (i) issue equity stock; or (ii) borrow
from the bank; or (iii) issue debt securities. In the case of
the former, the result of issuing equity stock is that the existing
stockholders, unless they subscribe to the issue, will have their
ownership in the corporation watered down. In the case of borrowing
money from a bank, interest rates may be high. However, with the
issue of a debt issue bond, corporations can take advantage of
not having to dilute their stockholding in the corporation, along
with the benefit of having a cheaper cost of funding (which will
depend in part upon the rating that a rating agency gives to the
bond issue).
The most common type of corporate bonds
issued include:
- Convertible bonds: which allow the holder of the bond issue
to convert their bonds into stock in the issuing corporation upon
certain circumstances arising (notably if the corporation fails
to make a dividend payment under the bond issue, etc.)
- Callable bonds: allow the issuing company to call the bonds
for early repayment before their maturity date. Callable bonds
are popular among issuing corporations because they allow the
corporation the option to make early repayment of the bond in
the event that the corporation is of the opinion that interest
rates are going up and it would be difficult to maintain the rate
of interest the corporation is currently paying on its debt issue.
- Zero coupon bonds: as the name suggests, this type of bond issue
pays no interest – i.e. Zero coupon. To make up for this,
and to entice buyers, the issuer will allow investors to purchase
the zero coupon bonds at a face-value price significantly marked
down (depending on when the maturity date is) from that at which
it is advertised. This way, both the investor and issuing company
feel better – the issuer because it has no lingering ongoing
interest payments, the investor because it can make a profit on
the sale of the bond in the future.
Debentures
Every known and then you may hear traders and investors talking
about a company issuing a debenture. Just so you know, there is
little or no overall difference between a debenture issue and
a bond issue, just a difference in the name.
Mutual Funds
Aside from equity and debt issues of US corporations, another
listed investment you will come across are mutual funds. Unlike
stocks and bonds, mutual funds are not corporate or government
issues, per se. What are they are is an investment vehicle that
needs to raise funds to invest in other listed securities. To
do this they list ‘units’ in a mutual fund, which
you can purchase.
Depending on the nature of the mutual fund, the mutual fund can
either be very specific, e.g. a property mutual fund that invests
in property related matters, or very diverse. In all cases the
mutual fund should be managed by professionals with stock market
experience.
By investing in mutual funds then, it is hoped that you can lessen
the investment risk as the persons with overall control over the
decision to buy and sell securities are the experienced mutual
fund managers.
Offering Circulars and Prospectuses
As previously mentioned, US securities issues work on a two-market
basis. First you have the primary market – which is the
issue of the securities from the corporation directly to investors
– then you have the secondary market – which is the
trading of the securities among investors. It is the second of
these where you’ll do your trading on the US stock markets.
However, federal laws require corporations issuing in the primary
market to issue offering circulars or prospectuses, depending
on the nature of the securities issue, to initial investors so
that the investor can have full disclosure about the previous
and likely performance of the corporation before electing to invest
in the securities issue.
As such, if you hear of the chance to invest in a securities
issue that has an offering circular or prospectus, then you know
you are dealing with the corporation directly and you are in the
primary market.
Secondary market trading does not come with offering circulars
or prospectuses. When you consider the merits of investing in
that instrument, you do so on a caveat emptor (“buyer beware”)
basis.
|
