The options for investing our savings are continually increasing, yet every single investment vehicle can be easily categorized according to three fundamental characteristics - safety, income and growth - which also correspond to types of investor objectives. While it is possible for an investor to have more than one of these objectives, the success of one must come at the expense of others. Let's examine these three types of objectives, the investments that are used to achieve them and the ways in which investors can incorporate them in devising a strategy.
Perhaps there is truth to the axiom that there is no such thing as a completely safe and secure investment. Yet we can get close to ultimate safety for our investment funds through the purchase of government-issued securities in stable economic systems, or through the purchase of the highest quality corporate bonds issued by the economy's top companies. Such securities are arguably the best means of preserving principal while receiving a specified rate of return.
The safest investments are usually found in the money market, which includes such securities as Treasury bills (T-bills), certificates of deposit (CD), commercial paper or bankers' acceptance slips, or in the fixed income (bond) market in the form of municipal and other government bonds, and in corporate bonds. The securities listed above are ordered according to the typical spectrum of increasing risk and, in turn, increasing potential yield. To compensate for their higher risk, corporate bonds return a greater yield than T-bills.
The safest investments are also the ones that are likely to have the lowest rate of income return or yield. Investors must inevitably sacrifice a degree of safety if they want to increase their yields. This is the inverse relationship between safety and yield: as yield increases, safety generally goes down and vice versa.
In order to increase their rate of investment return and take on risk above that of money market instruments or government bonds, investors may choose to purchase corporate bonds or preferred shares with lower investment ratings. Investment grade bonds rated at A or AA are slightly riskier than AAA bonds, but presumably also offer a higher income return than AAA bonds. Similarly, BBB rated bonds can be thought to carry medium risk but offer less potential income than junk bonds, which offer the highest potential bond yields available but at the highest possible risk. Junk bonds are the most likely to default.
Growth of Capital
This discussion has thus far been concerned only with safety and yield as investing objectives, and has not considered the potential of other assets to provide a rate of return from an increase in value, often referred to as a capital gain. Capital gains are entirely different from yield in that they are only realized when the security is sold for a price that is higher than the price at which it was originally purchased. Selling at a lower price is referred to as a capital loss. Therefore, investors seeking capital gains are likely not those who need a fixed, ongoing source of investment returns from their portfolio, but rather those who seek the possibility of longer-term growth.
Growth of capital is most closely associated with the purchase of common stock, particularly growth securities, which offer low yields but considerable opportunity for increase in value. For this reason, common stock generally ranks among the most speculative of investments as their return depends on what will happen in an unpredictable future. Blue-chip stocks, by contrast, can potentially offer the best of all worlds by possessing reasonable safety, modest income and potential for growth in capital generated by long-term increases in corporate revenues and earnings as the company matures. Yet rarely is any common stock able to provide the near-absolute safety and income-generation of government bonds.