Whether you're a seasoned investing pro or just dipping your toes into the investing waters, there's a term you've likely come across at some point: securities. The name can be a little misleading if you’re new to it—it has nothing to do with security or protection.
Instead, it's an umbrella term that essentially refers to any type of investment you can buy or sell. It casts a wide net, covering everything from stocks and bonds to shares of mutual funds and ETFs (exchange-traded funds). Think of it as any financial instrument that has some value attached to it.
"A security is any kind of investment relationship or investment contract in which the investor is basically a passive investor without any control rights," says John Coffee, Jr., a law professor at Columbia Law School.
Let's unpack exactly what that means. Securities are generally classified in one of the three following ways:
Equity securities usually refer to common stocks. These are investments that represent partial ownership in a business enterprise. Owning stock basically means that you have an ownership share in that company. In other words, you become a shareholder. As the business's value increases, its stock reacts in kind. Reaping a potential profit is what motivates investors to get in on the action.
So why do companies issue stock? It's an effective way to raise capital (a.k.a. money) so the business can grow and excel. Instead of turning to banks, for example, business owners and entrepreneurs can sell ownership stakes in their company and access liquid money now. This can be done in one of two ways: Seeking private investors — ever seen Shark Tank? — or doling out publicly traded stock via the capital markets. (We'll dig into this in just a minute.)
They're giving up a bit of equity every time they do so, but for most successful businesses, taking on investors comes with the territory.
"Most stocks will presumptively be a security, but not always," adds Coffee. "If you own shares in your co-op [apartment building], the courts will say you purchased that co-op more for consumption than for investment."
If you're going to be living there, you're not exactly a passive investor.
Debt securities are another way businesses raise capital, but it's a little different from the way stocks work. Sometimes called fixed-income securities, they generally refer to bonds. What is a bond? It's a loan that you, the investor, give an entity like a business or a municipality. The principal amount will be paid back later down the road, plus interest. It's easy to see why investors would be interested.
"In debt securities you are expecting a return, the interest on the bond and the repayment of principal, and you really will have no control rights over the enterprise and how it spends its money," says Coffee.
Corporate bonds certainly don't stand alone. Investors can also buy bonds from the government (a.k.a. Treasurys or municipal bonds) to help raise funds for a variety of goals.
A certificate of deposit (CD) is another type of debt-based fixed-income security in which you put money in for a predetermined amount of time in exchange for a higher return rate than you'd typically get with a standard savings account. If you don't need the money in the near future and are OK with parking it for the duration of the term, CDs are a great way to make your money work a little harder for you.
Other types of securities
Stocks and bonds aren't the only game in town. Other kinds of securities come into the mix, too, like hybrid securities, which can act as a combination of the two. Some companies also issue equity warrants, which allow investors to buy stock at a specific price on a set date (usually, the shareholder will pay a premium for this right).
Marketable securities, meanwhile, represent a way for companies to leverage cash reserves to provide liquidity to others. Traded on public exchanges, these are short-term securities that can be converted to cash relatively quickly. It allows them to earn some interest on their money, as opposed to letting their cash just sit there.
There are tons of nitty-gritty forms of securities, and there's no need to get too far in the weeds here. At the end of the day, a security is an investment that doesn't give you control rights in the enterprise.
How the markets work
When a company goes public and files for an initial public offering (IPO), it opens the door for ordinary folks to invest and become shareholders. It can be exciting for the general public — many may feel like they're finally getting in on the action of a major company. But investing in IPOs can be risky. And trying to time the market and pick individual stocks is generally a losing game. Investing in low-cost index funds, and staying the course over the long haul, is your best bet.
Either way, when a company first begins issuing stocks or bonds, they do so on what's called the primary market. (An example of this is when a company carries out an IPO.) After that, investors can buy and sell existing securities on the secondary market. This includes stock exchanges like the New York Stock Exchange and Nasdaq. Side note: The Securities and Exchange Commission (SEC) regulates the securities market and is tasked with protecting investors from shady business.
So who sets the prices? It's a loaded question. Institutional investors that gather up money and invest it for their members (think insurance companies and hedge funds) play a large part in swaying prices. And there's power in the herd—once a buying or selling trend starts, it can pick up momentum and influence individual investors. Economic conditions, political issues and earnings reports all come into the picture, as well. Put it another way: There isn't one clean reason why market prices fluctuate as much as they do.
The thing to remember is that the stock market is an inherently volatile place, and ups and downs simply come with the territory. While it's easy to panic during a downward period, these kinds of market cycles are completely normal. Keeping your emotions at bay and sticking to your investing plan is your best defense—that and diversifying your investments as much as possible. It’s smart to spread out the risk by peppering different sectors and companies from a variety of countries throughout your portfolio. This will prevent you from putting all your eggs in one basket.
When all is said and done, the stock market has historically gone up more than it's gone down. What's more, downturns are typically followed by upward swings. Translation: Stick with it.
Why invest in securities?
Parking your cash in a traditional savings account with a 1 percent interest rate won't do much to really move the needle on your big-picture money goals, whether we're talking retirement, saving for your kids' college funds or anything in between. Smart, long-term investing is the ticket to historically greater returns—and growing your wealth in a real way. You can thank securities for that.
* Investing involves risk including loss of principal. Past performance is no guarantee or indicator of future results. The forgoing is presented for educational use only and is not a recommendation to buy or sell any specific security or invest in any particular strategy