If you read financial news, you may have come across the term securities, referring to things like stocks and bonds. Essentially, the finance definition of a security is any kind of ownership in an organization or right to collect on its debt that you can buy and sell, often through public markets. Stocks are one of the most familiar types of security you'll encounter, with other common types including options, warrants and bonds.
Securities Vs. Stocks
A share of stock represents partial ownership in a company. Depending on the terms under which the stock was issued, stockholders can generally buy and sell their holdings for a potential profit, receive money from the company in the form of dividend payments if the company makes them and, often, vote in shareholder meetings to elect a corporate board or consider other critical questions. A share is generally the unit in which stock is sold, and multiple shares of the same type of stock in the same company are essentially interchangeable.
Stocks in many companies are available to buy and sell through common markets, such as the New York Stock Exchange and the Nasdaq. A company issuing stock generally issues a document called a prospectus outlining exactly what share ownership delivers.
Stock is just one type of what the finance world calls securities. These are essentially anything that represent an ownership, equity or interest in a company or the right to collect on its debt. Bonds, which represent loans, are another common type of security. Other more esoteric securities include warrants and options. Securities are generally regulated by the Securities and Exchange Commission and often by state regulators as well, so it can have a legal significance whether something is regarded as a security.
How Bonds Work
While stocks represent ownership in a company, bonds effectively represent a loan to the company or another organization, such as a government agency or nonprofit group. A bond entitles the owner to collect interest on a set schedule and then receive the face value of the bond back when its term ends.
Bonds can be bought and sold on an open market similar to stocks. Bond prices typically go down when prevailing interest rates are high, since people have more opportunity to get the same return elsewhere, and go up when interest rates are low. The effective interest rate at a bond's current price is known as its yield. Organizations often issue bonds to fund long-term projects such as construction operations so that they can pay off the debt over time rather than have to pay for all of the work up front.
Stocks and Bonds Investment Risk
Bonds, especially government bonds, are often considered less risky investments than stocks, although they generally also carry less possibility of reward, since a quickly growing company can see its stock price skyrocket while bond prices generally won't move so dramatically. Still, they're not without risk: If a company or other organization goes bankrupt, it may not pay back its bondholders.
Like individuals, companies and bonds have credit ratings assessing the risk of investing in their offerings. The riskiest bonds are sometimes known as junk bonds. They can provide a decent return on investment but also carry a high risk that the underlying company will default.
How Stock Options Work
In addition to buying stock directly, you can also buy another type of security, called options, that gives you the right to buy or sell the stock for a certain price at a certain time. Stock options are a particular type of the class of securities known as derivatives, which take (or derive) their value from another underlying asset, in this case a stock. Some companies also issue stock options to their employees as part of their income.
Options to buy stock are known as call options, since they give you the right to call for delivery of the stock, while options to sell stock or anything else are called put options. Buying and selling options can be a way to hedge, or reduce risk from, an investment in the underlying stock. They can also be lucrative on their own if they let you buy a stock at a bargain or sell it for more than the prevailing market price. The price that you can buy or sell the stock at is called the strike price or exercise price.
A similar type of security called a warrant also gives investors the right to buy a stock at a certain price. Warrants are usually issued by the company that issued the stock, while options can be issued by anyone.
Investing in Funds
It's sometimes worthwhile to invest in funds that invest in securities rather than buying the securities directly themselves. Some funds are actively managed, meaning that they employ expert investors to pick stocks, bonds and other investment opportunities. Others called index funds automatically buy stock from a basket of stocks on a market index like the Standard & Poor's 500 Index, Nasdaq Index or the Dow Jones Industrial Average. Index funds generally charge lower fees than traditional actively managed mutual funds.
Shop around to find a fund that makes investments you're interested in with a fee structure that makes sense for you. Take a look at who's issuing the funds, how they've performed in the past and any information they share about investment decisions.
You can invest in many funds through a broker of your choice. Some funds are only offered through the company that issued them. Others are bought and sold on exchanges similar to stocks. These are called exchange-traded funds.
Buying Stocks Through a Brokerage
You normally buy and sell stocks, bonds and other securities through a brokerage firm. They generally charge a commission each time you make a purchase or sale. The commission typically doesn't change with the amount of stock you buy or sell, so it can be to your advantage to do big trades all at once. Buying and selling more esoteric securities, such as auctions or stocks traded off of the major exchanges, sometimes carry heftier fees.
Some online brokerages offer low commissions, flat monthly fees or even no fees at all. Other brokerages charge higher fees but offer additional services, such as investment advice, online research tools or access to exclusive sets of funds. Look to find a brokerage that offers the services you want with a fee structure that meets your needs.
Securities and Taxes
The goal of investing is usually to buy low and sell high, as the saying goes, and if you do so you will earn some income. Like other types of income, this money is taxable by the federal government and many state and local tax agencies.
If you hold on to an investment for a year or more, you are normally taxed at the federal long-term capital gains rate. This is 15 percent for most people, but can be 0 percent or 20 percent for some taxpayers, and is usually substantially lower than the ordinary income tax rate. If you hold on to investments for less than a year and sell them, you will be taxed at your ordinary income tax rate instead.
If you lose money on an investment and sell it or it becomes worthless, you can claim a capital loss on your taxes. Capital losses can offset capital gains and up to $3,000 in ordinary income per year. If you have more losses in a year than you can deduct, you can roll them over into future tax years.
Video of the Day
- The Street: What Are Securities?
- Investopedia: Security
- Investopedia: Bond
- Investopedia: Junk Bond
- Investopedia: What is a Derivative?
- Investopedia: Incentive Stock Options
- Investopedia: Warrants
- Investopedia: Exchange-Traded Funds
- NerdWallet: Best Online Brokers for Free Stock Trading 2019
- IRS: Topic Number 409 - Capital Gains and Losses