This post contains opinion of Misook Yu. Do not solely depend on this to make your investment decision and consult an investment advisor/financial advisor before investing. 

Definition of Security

A security represents any ownership that has financial value. Examples of a security can be very broad and can include business partnerships, options and futures, farm animals, and oil and other mineral rights. But we will focus on several types of securities that can easily be bought and sold by typical investors at a stock exchange: stocks, bonds, mutual funds, and ETFs. The following contains only basic information, and each security has many more characteristics that investors need to consider before investing.
Securities are largely divided into two categories: debt and equity. Funds that are invested in debt securities are called debt funds, and funds that are invested in equity securities are called equity funds.

Debt Securities

Debt securities are issued by organizations (issuers) to borrow money from investors, and in return, the issuers pay the investors periodic interest payments. Bonds and CDs are typical debt securities. When you buy a bond, you loan the issuer money, and you receive fixed interest payments called coupons, regularly (typically semi-annually). The issuers are obligated to continue the interest payments until they return the total amount (face value) they borrowed from you at the end of the term (maturity). Coupons are lower for highly rated bonds such as US Treasury bonds because they are considered safer than those with lower ratings. If you buy a bond at its issuance and hold it until the end of its life (maturity), your initial investment is paid back to you. These features of regular interest payments and the return of investment at maturity are two of the main reasons many retirees prefer bond investments over stock investments, even though a typical bond interest rate is lower than historic stock market performance. But the risk of owning bonds is the potential loss of purchasing power because the amount of interest payments don’t increase with inflation and the return of initial investment (face value) is likely to be worth less at maturity than may be in 10 or 20 years, due to inflation.
Although bonds can be bought and sold at an open market, you may or may not get the full price for what you paid if you want to sell it before maturity. In times when interest rates are increasing compared to when you purchased the bond, your bond price will be lower. That’s because, for example, if your bond pays less money than the market, who would want to buy it when other bonds with higher payments are available? You need to compromise your bond’s low payments by lowering the price if you want to sell it. Likewise, in times of decreasing market interest rates, if your bond pays higher payments than other comparable bonds, more people would want yours, which increases the market price of your bond. But in either case, as a bond gets closer to its maturity, its market price gets closer to the face value ($1,000 in most cases). Types of bonds include corporate bonds issued by companies, T-bonds issued by the US Treasury and municipal bonds issued by local governments and municipalities.

Equity Securities

Equity securities, which are often referred to as common stocks, represent ownership of an organization. When you buy a share of a company, say Microsoft, you buy a piece of ownership of Microsoft. As a part owner of the company, which is called a shareholder, you have the right to vote on some issues such as the executive officers’ compensation packages and a proposed merger. As the company grows, the value of your stock increases, and the company may pay shareholders dividends. If the company doesn’t do well, however, your stocks will lose value, and if the company were to go out of business, you are likely to lose all your investment. Since you are a shareholder (part owner), not a bondholder, the company is not obligated to pay you periodic fixed interest payments. One of the main reasons that investors invest in stocks, instead of bonds that pay interest payments and return the face value at maturity, is because unlike bonds which have inflation risk as explained above, stocks have less probability of losing purchasing power over time since they react immediately to inflation rates. Preferred stocks have characteristics of both debt securities and equity securities because they pay dividends like coupons in bonds, but they are stocks with no maturity.
Other than by industry sectors, stocks are also categorized in many ways, and the following show some that are commonly used.

• Small caps are stocks with lower market capitalization between approximately $300 million and $2 billion. Market capitalization, which is calculated by multiplying outstanding shares and market price, can frequently change.  Some “hidden gems” may be found in these stocks because they are often not known to the majority of investors, but for the same reason, the risk may be high as well.
• Mid caps are stocks with medium capitalization of approximately $2 billion to $10 billion. As stated above, companies’ market capitalization can frequently change based on stock price, which is why the amount can only be approximated. Some companies may categorize these with a different market capitalization amount.
• Large caps have over $10 billion in market capitalization.
• Blue chip stocks are shares of large and well-established companies with steady growth and often with less volatility than other stocks. Many blue chip stock prices tend to move closely with the S&P 500 Index. The name comes from the game poker where blue chips have the highest value.

• Income stocks  pay dividends almost like interest payments (coupons) in bonds. But companies are not obligated to pay dividends to common stock shareholders while coupon payments in bonds are legal obligations. Unlike coupons in bonds which are fixed until maturity, dividends of income stocks tend to grow over time. Shares of utility companies and equity REITs (real estate investment trust) are examples in this group. Investors who want income and growth (though maybe little) often invest in income stocks. Income stocks tend to be less volatile than the market.
• Value stocks are believed to be undervalued, and therefore, have room for higher growth potential. They tend to have a low price to book (P/B) value or low price to earnings  (P/E) ratio, and they may also pay dividends. Investors who expect a foreseeable future price increase with some dividends along the way tend to buy these securities.
• Growth stocks are stocks of companies that tend to be newer and faster-growing with more innovative ideas than others in the sector or industry . They tend to use most of their earnings on expansion instead of paying it out to shareholders as dividends, and investors who mainly focus on future profits tend to invest in these stocks. Although most of the companies in this category tend to be newer and smaller, large and financially well-established companies (blue chip stocks) like Google and Starbucks are defined as such.

Mutual Funds

One of the long debated arguments in securities investment is that individual stock investment is risky. This is especially true if you don’t have enough money to adequately diversify because you cannot afford to buy many different stocks from different industries with limited funds. If you invest all of your money in the stocks of three companies and one of them goes out of business, for example, you’d lose one-third of your total investment. But if you instead invest equally in 100 companies and several of them go bankrupt, the negative impact on your portfolio would not be as big.
Mutual funds can address this dilemma of individual investors. A mutual fund is issued by an investment company that pools money from investors and invests the large pooled money in many companies, therefore spreading risk. There are many different types of mutual funds; income funds, growth equity funds, biotechnology funds, European funds, emerging market funds, money market funds, bond funds, and S&P 500 Index funds are only a few types of mutual funds. Mutual funds are either actively or passively managed.

• In actively managed mutual funds, investment changes are made as often as fund managers feel necessary, and investment securities in the funds may change frequently. The objective of actively managed funds is to perform better than the benchmark index. Because there is a cost associated with having fund managers, performing intensive research and having other resources, actively managed mutual funds cost more to own, meaning they have higher associated fees than passively managed funds. The biggest initial cost associated with owning actively managed funds comes from points: percentage that is charged to investors and usually is between 0%~ 6%, decreasing as the amount invested increases. If you invest $10,000 in funds with 6%, for example, only $9,400 will be invested in your account and $600 will be charged by the fund company. Then a large portion of it is paid as commission to whoever sold the fund. The points gradually decrease as the investment amount increases (called break points), usually going down to 0% if $1,000,000 or more is invested. Actively managed managed funds charge points, but all mutual funds have ongoing expenses, called the expense ratio, that may be as high as 2% per year. The expense ratio on actively managed mutual funds are significantly higher than passively managed mutual funds, and a portion of the fees continue to to be paid to whoever sold them. Fees on mutual funds vary and can be complicated to understand, so it’s very important that investors fully understand them before investing.
  
  Investors who believe that fund managers can minimize loss from down market and/or can perform better than the average market by actively managing funds tend to purchase actively managed funds.
• Passively managed mutual funds, as the name implies, are not actively managed by fund managers. Index funds are good examples of passively managed mutual funds where pooled monies are proportionally invested in the stocks in any given index, such as the S&P 500 or Dow Jones Industrial Index. Once invested, no active management is necessary because the price of funds would follow the index. Therefore, fees in passively managed funds are considerably lower than in actively managed funds. Investors who don’t believe that fund managers can continuously outperform the market prefer these funds over actively managed funds.

ETFs (Exchange Traded Funds)

Most ETFs are very similar to passively managed mutual funds that track indices. One of the main differences between the two is that ETFs are traded like stocks at a stock exchange, whereas mutual funds are traded only once per day. Because ETFs act like stocks that are traded by supply and demand, there are generally lower costs to own ETFs. However, investors need to be mindful of transaction fees that are incurred on each transaction and charged by a brokerage firm.