Investing in precious metals isn’t the first thing that someone thinks of when they put together their financial portfolio, and that is unfortunate because if after reading this you take a quick look at a chart tracking the price of gold or silver, you’ll understand why. Over the past five years, the price of gold has gone from approximately $650 per ounce to highs just under $1900 per ounce. I’ll leave you to do the math but you don’t need a calculator to realize that there is money to be made in precious metals. Gold is perhaps the best known of the precious metals and has always been seen as a symbol of wealth going back thousands of years. While gold is indeed a material that has industrial uses besides its better known attributes as a hedge against inflation and for making fine jewelry, it is primarily seen in the financial community as market indicators of various economic trends and the overall health and level of prices i the economy.

Why Are Metals Precious?

Gold is the precious metal most familiar to the general public. If you polled several thousand people a much higher percentage of them could tell you the approximate price of an ounce of gold than could tell you the price of any other metal or commodity. Along with gold the most closely watched, and most coveted precious metals are silver, platinum, palladium and the industrial metals such as copper and zinc. As mentioned, almost all of these metals have uses other than sitting in a vault and accumulating or losing value based on world events. From electronic equipment and automobile parts to fine jewelry and construction material, metals are valuable for many reasons. However, while demand for metals based on their utility will certainly effect the price where they trade on the global markets, other factors such as global politics, social unrest, and the financial and economic health of the global economy also play a key role in the price movement of precious metals. If you are thinking of investing in the metals markets it is important to understand that the price and value of your investment will change 24/7, and often due to the most bizarre and seemingly unrelated events.

How Do I Invest In Precious Metals?

This is a good question because unlike other investment product that are fairly easy to incorporate into your overall financial product mix, investing in precious metals requires a little more homework. The reason for this is due to the fact that there are a lot of different ways to profit when precious metals increase in value. One way to get into the metals market is simply to buy into a stock equity mutual fund that invests primarily in companies that mine for precious metals. Ask your investment adviser or someone that knows about these funds and you will find mutual funds that are 100% invested in the equity of corporations that mine gold, silver, and every other metal in countries around the world. As the price of metals change on the open market the value of these companies and their stocks will also change. There are also products knows as ETF’s, or exchange traded funds that are exclusively tied to various precious metals. These ETF’s are not household names to most people but they are becoming much more popular and much more commonly used by the everyday investor as a means to diversify an investment portfolio into the metals markets.

The more popular methods of putting your investment dollars to work in the precious metals market is through the purchase of coins minted from these metals. Whether antique coins or those much more well-known types such as the gold Krugerrand, coins are yet another way to get into the metals markets. Then of course there is simply buying bars of gold from the mint or government banks. But while gold bars are great material for Hollywood, with every known villain from The Joker to Dr. No attempting to steal the precious bars from Fort Knox, they aren’t really a practical means for the common investor to add gold to an investment portfolio.

Risky Metals

Precious metal investing isn’t for the faint of heart. Unless you are a professional trader with deep pockets  it is a market best left to the pros. Go back to the price chart referenced in the beginning of this article. Gold right now is at an extremely high level compared to any time in the last 5 – 10 years. A professional trader will be able to profit from buying and selling as it moves forward in either direction from this price level. The relative price of gold isn’t quite as important to them, especially if they are short term traders. On the other hand as an investor what would you do at this point? Buy gold today and perhaps risk the metal plummeting due to a price correction? Or wait for it to fall from these levels only to see it continue to ever higher historical levels while you sit on the sidelines wishing you had taken the risk and simply bought it. If you’re investment horizon is long term you might be able to afford to take that risk. If you are looking for quick returns, you have a better chance of hitting a home run off of Rafael Santanta.

My take: The price of all precious metals right now is somewhat perplexing. They are all at relatively high levels despite a low inflation environment around the world and sluggish economic activity that would tend to soften demand for metals on a number of fronts. The only factors that must account for the relatively high price of precious metals, and these factors are not to be taken lightly are global political unrest and the horrendous state of so many government budgets, which means that the market is pricing-in inflation down the road. Too risky for me.

The reason why this article is titled “Equities for the Investor” is because too often people that aren’t financial market professionals get involved with the stock market without know the difference between trading stocks and investing in stocks – and truth be told it isn’t all their fault. These days anyone with a laptop or smart phone can access a trading platform that gives you the ability to trade the equity markets from virtually any location around the world. The ability to “day trade” the stock market isn’t new. The dot.com bomb that exploded just after the turn of the new millennium was detonated in part by the millions of newbie traders that didn’t understand the difference between trading and investing nor did they fully appreciate the different risks involved in each approach to handling equities.

Investing Versus Trading

Investing versus trading is not a concept that is unique to the equity or stock markets but more people seem to be familiar with stocks and more comfortable investing in them than with other investment products. The concept of investing versus trading is a topic that deserves much greater attention than the following one or two lines that I will provide in reference to the equities market. I suggest that anyone that plans on taking an active part in managing your own investments should investigate this further. Suffice it to say that trading is a much more technically driven process that can, but not always, involve a much greater volume of transactions. Traders will buy and sell stocks all day long with the goal of profiting from each transaction. This is not to say that there are not long term traders and long term  trading strategies in the equity markets, there are. But long term trading of any financial product is really best left to the pros because they go into these strategies knowing how to manage the risk they are taking on in doing so. Investing rather than trading means taking a long term approach that incorporates not just the price movement of a stock or mutual fund, but your personal time horizon and expected return on these investments over the course of your lifetime.

The waters become muddied when people invest in a stock or mutual fund fully committed to this transaction as an investment, only to start trading in and out of the market like a day trader after watching way too much alluring price action. And, having access to every bit of information about the market and the ability to buy and sell equities at the click of a mouse has led many investors down the expensive road to uniformed and untrained day trading.

Equity Market Basics

A stock is your ownership, small as it may be, in a company. Just as governments, city agencies and corporations will issue interest bearing securities called bonds to raise capital, companies will do the same by going to the public and selling shares of their company via the stock market.  As a partial owner of the company you stand to make or lose money on your investment based on the price where shares of the company trade on the open market, The Stock Exchange. The better the company does, meaning the better they are at running their company and making money, the better your investment will perform.

Should I Invest In Stocks?

Perhaps the best reason to allocate a portion of your investment portfolio (remember investment portfolio, not trading account) to stocks is because you stand to make the highest possible return from them. However, investments in equities also carry a much greater level of risk so bear in mind you probably should only invest a portion of your total investment dollars in equities, and this portion should be a function of your age and your risk tolerance.  The further away from retirement you are the more risk you can manage, and vice- versa. These are volatile investments so as they say, whatever goes up can go down and if the price of your equities are falling at the same time you need to liquidate them to use the money, you could be faced with the difficult choice of waiting until the price goes back up before selling (if the price goes back up) or simply cutting your losses right then and there.

The individual investor with limited knowledge of the financial markets is probably better off  investing in equities through an equity mutual fund. These offer similar returns to owning individual stocks that you buy on your own but in the case of a fund, your money is pooled with other investors and then managed by financial market professionals. They then choose a variety of stocks from among similar companies in order to get the highest return possible for those investing in the fund. The stocks that these professionals choose for the fund will come from among those that fit into a certain criteria or prospectus that tells investors the types of investments in a particular mutual fund i.e. emerging markets, small cap funds, large cap funds etc.

Think Before You Invest

The two key words here being “think” and “invest.” Equities are one of the best investment vehicles for all but a few people but they do have inherent risks that are not necessarily found in other financial securities. Therefore make sure that you understand the nature of these risks and that you are prepared for both the best and worst once you get involved in these markets. If you aren’t you run the risk of falling down the slippery slope of investor turned reluctant, and poorer day trader.

My take: Equities are a great investment product for almost everyone, but given the 24/7 financial news cycles too often equity investors get spooked out of their investments and strategy. There are a variety of other investments that may make sense for your portfolio. I have a friend that became a private investor in businesses, one being an SEO company called VisibilityMAX.  The return has been tremendous.  Perhaps you might look into growing businesses and investing in them as part of your overall investment strategy. Most people need to take the time to identify their investment goals, set up and investment plan, and then stick to the plan. And for most people, it is best to consult with and make use of the assist a professional investment counselor.

Muni Bond Particulars

Like any other interest bearing security, municipal bonds are in their most basic form an IOU issued by a particular entity in order to raise capital. In the case of muni bonds that entity is usually an American city, local government or and agency of a local government. For example, you will find that most cities around the country issue bonds in order to raise funds for any number of reasons, but mostly as a means to supplement the city budget or for their cash management. You are probably also familiar with muni bonds issued by city agencies to fund specific projects such as road building, water treatment facilities, and other large scale projects that require large amounts of capital not included in the city budget. Muni bonds are a great vehicle for local governments to use to fund these infrastructure type projects and most if not all American cities have been taking advantage of this market for quite some time.  

One of the most important and distinctive aspects of a municipal bond versus other similar financial products is that in most cases the interest that you earn on investing in municipal bonds will be tax free, meaning that you will not have to show the interest income earned from investing in muni bonds as income on your federal or state tax return. This is extremely important for anyone who wants to earn tax free income, or as is the case with many wealthy investors, those who need tax shelters or investments in products that can reduce their overall income tax burden.

All Muni’s Are Not Created Equal

Within the heading “Municipal Bonds” there are several different types of muni bonds that you should be familiar with if you are considering this investment product. As with federal or U.S. Treasury securities, local governments such as The City of New York and their affiliated agencies will issue these securities with various maturity dates attached to them. Shorter term muni paper, that which matures in one year or less is called municipal notes while the longer dated version of these securities are called municipal bonds and they can mature anytime after one year depending on how the particular city or agency has structured the issue. The two main types of muni bonds are general obligation bonds and revenue bonds. General obligation bonds are the ones that you might be familiar with as these represent city expenditures that have to be approved by the voters. This is due to the fact that general obligation muni bonds are backed by the full faith and credit of the city government issuing them. Another way of saying it is that the taxpayers of city issuing these bonds agree to pay the holders of these securities and that tax revenues will be committed to do so. On the other hand, the underlying backing for revenue bonds comes from, yes you guessed it, revenue. Those investors holding revenue muni bonds can expect to be paid back from the money a city or city agency collects from tolls, or any other income from the project being funded by the bond. The most common projects associated with revenue bonds are toll roads, bridges, airports, water and sewerage treatment plants, hospitals, and various local housing projects.

Municipal Bond Returns

It is important at this point to note that the tax-free status of the income derived from investing in municipal bounds sounds like a very attractive deal for anyone interested in these investments. After all, who wouldn’t like to earn tax-free income? And on top of the tax-free status of muni investment income, another very good reason to consider adding them to your investment portfolio is that they are very secure, low risk investments. This is not to say no, risk, just low risk. Now comes the “But”…..but, bear in mind that because muni investment income is tax free and they are a low risk investment, they are also a very low return investment. You won’t get rich investing in municipal bonds. However, comparing a muni bond that pays you 2% to a corporate bond that pays you 5% is not fair or accurate in that your higher return from the corporate bond has to consider the tax implications, and higher risk associated with these bonds versus muni bonds.

To Buy Or Not To Buy

Muni bonds are a good investment for those people looking to park away some money into a risk security for which they won’t have to pay taxes. You generally find older investors who are close to retirement age parking funds in municipal bonds because the market for them is very liquid, meaning that you can cash out whenever you want and you don’t risk losing too much of your initial investment with them; both very important considerations for anyone that is close to putting their feet up after a long hard career. Extremely wealthy individuals are also good candidates for muni bonds due to the tax free nature of the income derived from them.

My take: Muni bonds aren’t the sexiest investment out there because they pay a very low rate of return. But far too often, especially among those not well-versed enough to know better, it is always a good idea to devote a portion of your investments to relatively safe, albeit low yield investments. The one thing that I would urge in this regard is that if you are investing in a safe investment product, just make sure that it is a very liquid product so that you can quickly cash out in order to devote the funds in these products for other investments should another opportunity come along that you would like to investigate. Liquidity is a benefit that should not be underestimated.

Mortgaged backed securities have been in the news quite a bit these past couple of years, and while they say that, ‘Any publicity is good publicity,’ for mortgage backed paper, this probably isn’t true. These securities have been making headlines because of the role that they played in the housing crisis that many fault for precipitating the entire financial crisis that ravaged the economy starting in late 2007. Before touching on why and how mortgage backed securities may or may not have played a part in our financial calamity, it is important to understand what these financial securities are, how they function, and if they are suitable for your investment portfolio. 

Investments Backed By Houses

Well, mortgage back securities aren’t exactly investments backed by houses – you can’t repossess someone else’s home if these investments go sour on you. However they are indeed connected to the housing market in that they are debt obligations, meaning that you pay someone money for these instruments and they in turn are obligated to you, that are tied to the flow of funds generated by mortgage payments made by homeowners to the banks. It gets a little complicated but stated as simply as possible, when a bank issues a mortgage to a homeowner, the bank doesn’t have to keep, or retain ownership of the loan, and in fact most don’t at least not for the entire tenure of your loan. When banks sell and pool all of the various mortgages they are holding it is know as securitization, a process that turns these loans into a financial instrument that can be bought and sold on the open market by almost anyone, including the individual investor. These investment products carry certain ratings and guarantees depending on whether they are backed by Ginnie Mae (Government National Mortgage Association) or Freddie Mac or Fannie Mae, which are other U.S agencies that are involved in the housing market.

Risk of MBS Investing

While mortgage backed securities are said to be backed by the above mentioned U.S. government agencies, this does not mean that there aren’t inherent risks associated with investing in these instruments or that your principal investment is particularly safe because of the role of these agencies in the administration of both the loans and the securitization of the product. These are simply agencies that have the ability to borrow money from the federal government and to provide support and liquidity to the market if necessary. Interest rates and your rate of return on a  mortgage backed security will rise and fall based on the prevailing interest rates at the time that you purchase this type of investment. The price you pay for this investment will be a function of prevailing interest rates, as mentioned, as well as the quality or rating of the loans within a particular group of mortgages underlying the security, as well as the coupon or interest rate that is being paid by those paying the mortgages. The most basic risk in purchasing a mortgage backed security is the same as that of any interest bearing investment. If interest rates go up after you buy into an MBS fund you will lose money. If interest rates go down after you buy into these investments you’ll earn a profit.

The other risk associated with mortgage backed securities, other than market risk, is credit risk. Credit risk is best described by how this investment is viewed by the market. If U.S. Treasury securities have the highest credit rating in the world, and that rating rarely changes, there is little or no credit risk associated with investing in them. All other instruments have associated credit risk to a greater or lesser degree and this risk changes as often as the market perceives that the risk with  ”what lies beneath” your investment changes. For instance, if you own a bond issued by the government of Greece that pays an interest rate of 8%, and the next day you hear that the government of Greece may default on its debt obligations, interest rates and the credit risk associated with Greek bonds will soar and your bonds will be worth much less than when you first bought them. With mortgage backed securities the same holds true meaning that if you buy into a MBS fund one day, and the housing market collapses the next, the much greater credit risk attached to these investments will undermine your return.

MBS Getting a Bad Rep

MBS have indeed gotten a bad reputation because when the housing market collapsed, so did the value of these investments. And more to the point, many industry experts and outside observers will tell you that in creating these MBS products, too many very risky home loans were included in the mix and when the market went bad it caused the entire pool of securities to go bad, or toxic, too. The real crime was probably in the fact that most of the people involved in the process were well aware that these loans should never have been used for an investment product in the first place.

My take:  Be careful….be very careful because the recent experience with MBS and the housing market should teach everyone that even when a rating agency or some other such group of sharpies tell you that it safe to go into the water, you should think twice, especially when it comes to your hard earned money. The reason I say this is because there is nothing inherently risky about mortgage backed securities as long as everyone involved is following the rules. They are grouped and rated based on their risk and then buyer beware. However, market risk is one thing, a scam of biblical proportions created by the bankers and investment bankers is quite another and this is exactly what happened in the MBS market.

One of the most popular and safest investment vehicles in the world are U.S. treasury securities. These securities are basically an I.O.U from your Uncle Sam, for which the government will pay you interest for lending money to the U.S. government. The reason why they are considered the safest investment vehicle in the world is because they are. This is not a matter of opinion though some might argue that it will be. The United States has never failed to honor its obligations on outstanding debt, ever, and because of that U.S. treasury securities are the highest rated investments in the world.  Recent budget issues surrounding the U.S. fiscal picture have prompted these securities to be downgraded by several rating agencies, but that is a topic for another article and despite the downgrade, U.S government paper is still the safest investment vehicle in the world. However, you should also bear in mind that you pay a price for that safety and a good rule of thumb to follow is that the greater the return expected on a particular investment, the greater the risk associated with that investment. And an even more important rule to consider is that even though bonds are safe you can still lose money investing in U.S. treasury bonds.

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Various U.S. Treasury Securities

The reason why the title of this section is U.S. Treasury Securities and not U.S Treasury Bonds is because not all U.S securities are bonds, which is one of several key things to know before lending any of your money to Uncle Sam. The United States government, like most every government and major corporation in the world reaches out to the world financial markets to borrow money. Even if the government budget is in a surplus, yes there was a time, they will still go to the market to raise money for all of the many programs and projects that fall under the heading of government spending. The agency of the U.S. government that oversees the process of issuing Treasury securities is the Treasury Department, not the Federal Reserve bank. The Treasury will issue securities with various maturity dates from 30 days out to 30 years. Treasury bills are securities that mature in one year or less, Treasury notes are securities that mature in from 2 years out to 10 years, and Treasury bonds are those securities that mature in 15 to 30 years.

Understanding U.S. Treasury Securities

Treasury bills are issued at a discount and they really aren’t a viable investment vehicle for the average investor. For one thing, they mature in such a short period of time and the other is that these days the return is minimal if anything. T-notes and T-bonds are interest bearing securities, backed 100% by the full faith and credit of the United States government, which pay interest to the holders of these securities every six months. These are also investments that in and of themselves are generally within the realm of much larger investors that can afford to buy blocks of this paper when they are auctioned by the Treasury. These investors are usually large corporations, pension funds, sovereign governments, and other such entities. The individual investor can also purchase U.S. treasury paper, but the most common way to invest in these vehicles is through a bond fund offered by a bank or investment banking firm.

What Will I Earn Investing In U.S. Treasury Securities?

It is very important to understand that the yield, or your return on your investment on Treasury notes and bonds is not necessarily the interest rate that is attached to the particular note or bond you own. Confused? Well, you aren’t alone and that is why is is usually best for small and medium investors to invest in a bond fund rather than thinking about purchasing these instruments when they are auctioned.  Bonds and bond funds are sold based on current interest rates, which are dictated by supply and demand in the market and change 24/7 without fail. To illustrate the difference between your rate of return versus the coupon, or rate of interest on the security, think about it this way. The treasury issues a 10 year bond on day 1 with an interest rate attached to it at 5%, meaning that anyone that purchases that note the second it is issued, and who holds it for its full maturity of 10 years, will earn 5% on their investment. Now it’s one month later and the person who owns that T-note wants to sell it to you. However, during the course of the month interest rates have declined to 4%, meaning that he or she only has to offer you a 4% return because that is where the market is today for 10 year T-bonds. You will have to pay a premium for this piece of paper, meaning that instead of say $100 you will have to pay $110 for that note. On the other hand, if rates go higher, you will be able to buy that 5% coupon T-note at a discount, say $90 versus $100. You see, I told you it was confusing.

The Bottom Line

Bonds are generally safe investments and you can find out the rating for bonds being issued by any country or corporation from one of the many rating agencies. And before investing in anything but U.S. treasury securities you should do so. However, even U.S. Treasury bonds are risky if you don’t plan on holding them until they mature, especially if you buy into a bond fund when interest rates are low and rising. In fact, you risk losing a significant portion of your principal investment if you buy into bonds and then try to sell them after interest rates have moved higher. As with all other investments, do extensive homework before buying bonds or into a bond fund.

My take:

Bond yields are quite low and its hard to imagine that they will drop any further. This presents significant risks for anyone thinking about investing in bonds right now. For those savvy investors that were smart enough to be in bonds during this historical time in U.S. interest rates, congrats and perhaps you should think about taking some profits. For the rest of us, steer clear for a while because if you buy now and interest rates start moving in the only direction left to go, up, your investment portfolio will be in trouble.