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Financial Literacy - Financial tuneup
OVERVIEW
Investing fundamentals
Here's the lowdown on the pros and cons of the basic types of investments.
Investment tuneup

Building blocks for successful investing

Investing sounds intimidating to the uninitiated, but a little knowledge can go a long way. If you're building a portfolio for the first time, set up a strong foundation with some of these common types of investments. Find them in a variety of places, including discount brokerage firms, mutual fund firms, banks and even the Treasury.

Investments:
Stocks
Mutual funds
Bonds
TIPS
REITs
ETFs
CDs

Stocks
One share of stock represents a slice of ownership in a business. Companies generally sell pieces of the business to the public in order to raise money. In return, stockholders may receive a share of company earnings through dividends. Investors who sell their stock after it has increased in value also benefit from capital appreciation.

After an initial public offering, stocks are sold on the secondary market -- where most of the daily trading takes place.

Most financial planners recommend that individual investors put their money into stocks through mutual funds.

Advantages and disadvantages of stocks
Pros
Individual stocks offer a potentially high rate of return, which is the reward investors expect for taking on risk. "Since the 1930s the stock market has done the best; the drawback is the volatility," says Carol Friedhoff, Certified Financial Planner, or CFP, and author of "Keep Investments Simple But Sweet."
Stocks can make investors rich. But with individual stocks, it's difficult to accurately predict which companies will take off like a rocket and which ones will languish or even fizzle out altogether.
Cons
Downturns in the market or within an industry can hit individual stocks pretty hard. "With an individual security you pick up something that is called nonsystemic risk, and that is the risk associated with one particular stock, associated with the management team of the company, their financial situation and the industry that they're in," says Kevin Brosious, a certified public accountant, or CPA; CFP; and president of Wealth Management Inc. in Allentown, Pa.
It's a risky bet. Diversification mitigates risk, so in order to avoid exposing all of your money to the twists and turns of a few individual stocks, spreading your money over several investments makes the most sense. "If you're putting money directly into stocks, you really need to have a large amount of assets because you want to have a number of different stocks," says Mike Flower, a partner in Financial Principles LLC in Fairfield, N.J. "You can feel very strongly about a stock, but if it's more than 5 percent of your overall portfolio, then it really starts to direct the ship." He focuses on building a strong foundation with funds and then sprinkling in individual positions later, if at all.
-- Updated: June 11, 2009
 
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