Investor Facts: What Is A Security?

Security is a synonym for a financial investment purchased in the markets, be it a stock or bond.

The reason we invest is to increase the long-term value of cash. Broadly speaking, there are two ways do to that: Own a piece of a corporation via the stock market or lend money to a company or government by way of a bond.

The stock security generates growth by increasing in value and by delivering a dividend, which can be taken as income or reinvested. The bond security also can increase in face value and it pays periodic interest to the bond holder.

Both types of investments represent the cash that has been provided to the issuer in exchange for the specific investment. The issuing entity then takes the cash and uses it to finance growth or to build something.

While a security usually takes the form of a stock or a bond, there are hybrids, such as preferred stock, and ways to access stock without buying directly, such as by purchasing options.

Presumably, investing in a security will result in a rate of return. The investor hopes that the return will be greater than inflation, thus protecting the purchasing power of the invested cash.

The way to buy a security is through a stock exchange, often with the help of an intermediary such as a stock or bond broker. Many long-term investors, however, prefer to avoid picking among stocks or bonds and instead buy a mutual fund.

Low-cost diversification

The mutual fund buys and sells a variety of securities in a bid to create a steady, predictable, long-term return while diversifying the investor’s position. Owning a lot of different securities, or diversification, is one way to reduce the risk of putting too much cash into one security or another.

Similarly, index funds diversify by owning all of the securities within a single index or exchange. The amounts of each are set not by a manager’s decisions but by the weight of that security relative to all others.

Investing in an index fund or exchange-traded fund thus lowers the cost of securities investing while increasing diversification. Since there is no broker and no fund manager to oversee the process the cost can be dramatically minimized.