Financial instruments: Stocks, Bonds, Funds

Financial instruments are essential tools for raising funds, investing, and managing risks. Stocks, bonds, and funds offer investors various opportunities to achieve their financial goals, but they also come with their own risks and return expectations. Stocks can provide high returns, while bonds offer more stable returns in a less volatile environment.

What are financial instruments?

Financial instruments are economic tools used for raising funds, investing, and managing risks. They can be stocks, bonds, or funds, and they enable investors to achieve different financial objectives.

Stocks: definition and characteristics

Stocks are ownership rights in companies that give investors the opportunity to participate in the company’s profits and decision-making. Stocks can be either common or preferred, and their value fluctuates based on market demand and supply.

Characteristics of stocks include dividend payments, which can provide investors with regular income. Additionally, stocks offer the potential for capital appreciation, but they also carry risk, as market prices can vary significantly.

• Stocks provide ownership in a company.
• Dividend payments can generate additional income.
• Capital appreciation is possible, but risks are high.

Bonds: definition and characteristics

Bonds are debt instruments in which an investor lends money to an issuer, such as a government or corporation, in exchange for interest. They are generally less risky than stocks and offer predictable returns.

The benefits of bonds include stability and regular interest payments. They can be short-term or long-term, and their value may fluctuate based on market interest rates.

• Less risky than stocks.
• Provide regular interest payments.
• Can be short or long-term loans.

Funds: definition and characteristics

Funds are investment instruments that pool money from multiple investors and invest it in various asset classes, such as stocks and bonds. They offer diversification and professional management, which can reduce the risk for individual investors.

The operation of funds is based on investors purchasing shares in the fund, and the fund manager makes investment decisions. Funds can be actively or passively managed, and their fees vary.

• Provide diversification in investments.
• Professional management reduces risk.
• Fees can vary depending on the type of fund.

The role of financial instruments in investing

Financial instruments are key tools for investing that help investors achieve their financial goals. Stocks, bonds, and funds offer different opportunities and risks, and combining them can enhance portfolio returns and reduce risk.

Investors should consider their own risk tolerance and time horizon when selecting financial instruments. Combining different instruments can help balance the portfolio and achieve desired outcomes.

Market trends in financial instruments

There are constantly changing forces in the market that affect the demand and supply of financial instruments. For example, the prices of stocks and bonds can fluctuate based on economic conditions, interest rates, and geopolitical events.

In recent years, there has been a growing interest in responsible investing, which has influenced the structure of funds. Investors are increasingly seeking environmentally friendly and socially responsible options, which is changing the dynamics of the market.

What are the advantages and disadvantages of stocks?

Stocks offer investors the opportunity to participate in the growth and profits of companies, but they also come with significant risks. The return expectations for stocks can be attractive, but market volatility and liquidity are factors to consider before investing.

Potential returns of stocks

The return expectations for stocks can vary widely, but over the long term, they are often higher than those of traditional fixed-income instruments, such as bonds. Historically, stocks have returned an average of about 7-10 percent per year, considering dividends and capital appreciation.

Stocks can also provide dividend income, which is a regular payment to shareholders. Dividend yields vary by company and can be a significant part of an investor’s total return.

Market trends influence stock return expectations. For example, in a bull market, stocks can rise rapidly, while a recession can push prices down. It is important for investors to monitor market trends and assess how they may affect stock returns.

Risks and volatility of stocks

Stocks are known for their high volatility, meaning their prices can fluctuate significantly in a short period. This can lead to substantial gains as well as significant losses, making risk management essential.

One of the risks associated with stocks is market risk, which relates to general economic conditions and market trends. For example, economic crises can affect the entire stock market and lower stock values.

Another risk is company risk, which relates to the financial performance of individual companies. Poor results or scandals can negatively impact stock values. It is important for investors to research companies’ backgrounds and financial situations before investing.

Liquidity of stocks

The liquidity of stocks refers to how easily stocks can be bought or sold in the market without significant price changes. Large and well-known companies typically have good liquidity, meaning their stocks can be traded quickly.

Liquidity can vary between different stocks. Smaller and less well-known companies may have lower liquidity, which can lead to greater price fluctuations during trading. Investors should be aware of liquidity risks, especially if they plan to make large trades.

Good liquidity is important, especially in short-term trades where quick responses to market changes are essential. Investors should check the trading volume and market conditions of stocks before making investment decisions.

What are the advantages and disadvantages of bonds?

Bonds offer investors the opportunity to receive stable returns, but they also come with risks. They are particularly attractive to those seeking less volatile investments compared to stocks.

Potential returns of bonds

The return expectations for bonds vary, but they generally offer lower returns than stocks. On average, the annual return on bonds can range from low percentages to high single digits, depending on interest rates and market conditions.

Long-term bonds can offer higher returns, but they are also exposed to interest rate risk. An increase in interest rates can decrease the value of bonds, affecting the investor’s return.

Short-term bonds typically offer lower returns but are less susceptible to interest rate fluctuations. Investors can choose bonds based on how much risk they are willing to take.

Risks and stability of bonds

Bonds come with several risks, including credit risk, interest rate risk, and inflation risk. Credit risk refers to the possibility that the issuer may not be able to pay back interest or principal.

Interest rate risk affects the value of bonds, especially in long-term bonds. If market interest rates rise, bond prices fall, which can lead to losses in a selling situation.

Stability is one of the advantages of bonds, as they provide regular interest payments, making them more predictable compared to stocks. This makes them attractive to investors who value predictability.

Liquidity of bonds

The liquidity of bonds varies by market. Large and well-known bonds, such as government bonds, are usually very liquid, meaning they can be sold quickly without significant depreciation.

On the other hand, smaller or less well-known bonds may be less liquid, making them harder to sell. Investors should consider liquidity before making investment decisions.

Liquidity is an important factor, as it affects how quickly and easily an investor can convert bonds into cash when needed. Investors should assess their liquidity needs before investing in bonds.

What are the advantages and disadvantages of funds?

Funds offer investors the opportunity to diversify their assets and benefit from professional management, but they also come with risks and costs. By understanding the advantages and disadvantages of funds, investors can make more informed decisions.

Potential returns of funds

Funds can provide investors with competitive returns that vary based on market conditions. For example, equity funds can yield an average of 5-10 percent per year over the long term, while bond funds may offer lower but more stable returns, such as 2-5 percent.

Returns also depend on the fund’s investment strategy and asset allocation. Passive index funds can provide returns that track market indices, while actively managed funds aim to outperform the market.

Risks and diversification of funds

Investing in funds involves risks, such as market risk, which can affect the fund’s value. Diversification is one of the biggest advantages of funds, as it can reduce the risk of individual investments. For example, an equity fund that invests in multiple companies can protect the investor from poor performance of individual stocks.

However, while diversification can reduce risk, it does not eliminate it entirely. Investors should be aware that markets can decline and affect all funds simultaneously. Therefore, it is important to assess one’s risk tolerance before investing.

Liquidity of funds

The liquidity of funds varies by fund type. For example, open-end funds generally offer daily liquidity, allowing investors to easily buy and sell shares. This makes them attractive to those who need quick access to their funds.

However, closed-end funds or specific alternative funds may be less liquid, and selling them may require more time or even restrictions. Investors should check the liquidity of the fund before investing to understand how quickly they can access their funds if needed.

How to choose the right financial instrument?

Choosing the right financial instrument depends on several factors, such as investment goals, risk tolerance, and market conditions. It is important to evaluate which instrument best supports your financial objectives and fits your risk profile.

Defining investment goals

Investment goals can range from seeking short-term profits to long-term wealth growth. Define whether you want to save for retirement, buy a home, or finance your children’s education.

Clear goals help in selecting suitable financial instruments. For example, if your goal is short-term profit, stocks may be attractive, while for long-term goals, bonds or funds may be better options.

Also, remember that goals can change over time, so it is good to review and update them regularly.

Assessing risk tolerance

Risk tolerance refers to the ability to withstand market fluctuations and potential losses. Assess how much risk you are willing to take relative to expected returns.

Generally, younger investors can take greater risks because they have more time to recover from potential losses. Conversely, older investors may prefer more stable instruments, such as bonds.

You can use various tools to assess risk tolerance, such as questionnaires or risk profile analyses, which help you understand your investment style.

Analyzing market conditions

Understanding market conditions is key to selecting the right financial instrument. By monitoring economic cycles, interest rates, and inflation, you can make informed decisions.

For example, if economic growth is strong, stocks may offer good returns. Conversely, in a weak economic situation, bonds may be a safer option.

Also, analyze different sectors and industries, as they may react differently to market changes. Diversifying across different instruments and sectors can reduce risk and improve return expectations.

Where can I buy stocks, bonds, and funds?

Stocks, bonds, and funds can be purchased from various places, such as brokers, online banks, and investment services. These options offer different trading platforms and services that can affect investors’ choices and trading costs.

Brokers and trading platforms

Brokers provide access to the markets and enable the purchase of stocks, bonds, and funds. They can be traditional banks or online brokers that offer low trading costs and user-friendly platforms.

When choosing a broker, check the following:

• Trading costs and fees
• Offered trading platforms and their ease of use
• Quality and availability of customer service

Popular trading platforms in Finland include Nordnet and Degiro, which offer competitive prices and a wide range of investment options.

Online banks and investment services

Online banks often offer investment services where customers can buy and sell stocks and funds directly from their bank accounts. This can be convenient, but it is important to compare the services and costs offered by different banks.

The advantages of online banks include:

• Easy access to your investments
• Integrated banking services
• Often low trading costs

For example, OP and Danske Bank offer online banking services that include investment opportunities and advice.

Financial advisory services

Financial advisory services help investors make informed decisions about their investments. They can provide tailored investment plans and advice on selecting various financial instruments, such as stocks and bonds.

A good financial advisor takes into account the client’s financial situation, risk tolerance, and investment goals. Advisory services can be obtained through both banks and independent experts.

When choosing a financial advisory service, pay attention to:

• The advisor’s qualifications and experience
• The costs and fee structure of the service
• The quality and availability of customer service

What are the tax aspects of financial instruments?

The tax aspects of financial instruments vary between stocks, bonds, and funds. It is important to understand how the returns from different instruments are taxed and what potential tax deductions may apply.

Taxation of stocks

The taxation of stocks is primarily based on capital income taxation. In Finland, capital gains from stocks are taxed at 30 percent or 34 percent, depending on the amount of income. For example, if you sell stocks at a profit, you can deduct the acquisition cost and any trading expenses from the taxable gain.

Dividend income is also subject to tax, and the tax rate on dividends can vary depending on the payer and the amount of the dividend. Generally, dividends from unlisted companies are taxed at a higher rate than those from listed companies.

Taxation of bonds

The taxation of bonds generally occurs through capital income taxation. When you invest in bonds, you typically receive interest income, which is taxed in the same way as dividends from stocks. Interest income is taxed, and the tax rate is the same as for other capital income.

If you sell a bond before maturity, you may also realize a capital gain, which is taxed in the same way as capital gains from stocks. It is important to note that the taxation of capital gains from bonds may vary depending on how long you have held the bond.

Taxation of funds

The taxation of funds is somewhat more complex than that of stocks or bonds. The returns from investment funds are generally taxed as capital income. If you sell fund shares at a profit, you can deduct the acquisition cost and trading expenses from the taxable gain.

For funds, it is also important to note that some funds may distribute dividends or interest income, which are taxed separately. Taxation deadlines and potential tax treaties between different countries can also affect how the returns from funds are taxed.