Securities

Securities are financial instruments representing financial value, usually in the form of ownership of a company or another entity. Securities are fungible and tradeable assets that investors can buy on financial markets. 

Not all financial instruments are securities. To qualify as a security, a financial instrument must meet several criteria. In the United States, the Securities and Exchange Commission plays a major role in defining securities, building its frameworks around the Howey Test with the following criteria:

Equity securities represent the ownership share of the entity’s equity (total assets minus total liabilities).

Deb securities represent a loan made by an investor to the borrower, the issuer of debt securities.

Hybrid securities are financial instruments that combine traits of debt and equity.

Derivative securities are financial instruments whose value depends on underlying securities.

Collective investment schemes combine two or more financial instruments, including stocks, bonds, cash, and commodities.

Securities, particularly stocks and bonds, generate regular passive income. Companies that issue dividend stocks pay a portion of their profits to stockholders, usually quarterly. 

The dividend rate depends on the company. There are low-yield stocks like Apple stock, which pays 0.55% annually, and high-yield stocks, like Appolo Commercial Real Estate, which generates a 13.83% annual yield. A well-balanced portfolio can generate between 2% and 8% annually in dividends alone, excluding price appreciation.

With bonds, you can earn predictable passive income as they provide a fixed interest rate, while the bond issuer is typically the government. For instance, the U.S. Treasury issues Series I savings bonds at a 4.3% annual rate.

Stocks allow investors to build generational wealth through capital appreciation and dividends. Stock is tied to the issuer’s performance. If the company scales operations, grows in size, and boosts revenues, its stocks also increase in value.

Thus, Apple stock has grown over 110,000% since Apple Inc.’s inception. If you had invested $1,000 in AAPL stock at its IPO in 1980, you would have capitalized $1.1 million (adjusted to the stock split). Microsoft stock has gained 340,000% since its inception, while GOOGL stock has added over 4,000%.

Inflation devalues money and reduces purchasing power over time. An item purchased for $1,000 in 1980 now costs $3,700, which is a 270% increase. A $1,000 reserve kept under a mattress since 1980 has a real purchasing power of $370 in 2023. Meanwhile, securities, particularly stocks and bonds, are reliable tools to combat inflation due to regular payouts and value growth. If you had kept $1,000 in U.S. Treasury bonds since 1980, you would have ~$8,200 by the end of 2023 due to interest-based compound growth.

Some securities can help you maximize returns by minimizing taxes. You can invest in tax-exempt ETFs and municipal bonds to avoid federal taxes. Advisory services, like Morningstar, list tax-free bonds on federal, state, and local levels.  Meanwhile, with corporate bonds, you will pay a 37% tax on your returns.

Common stocks, like GOOGL: Alphabet Class A shares, give you voting rights in respective companies, allowing you to influence their decision-making processes. Companies maintain regular communication with shareholders and consider their votes while making corporate decisions, like mergers and acquisitions (M&A), board elections, or dividend payouts.

It allows you to directly influence the company’s strategic development to maximize your return on investment. The more common stocks you own, the higher voting power you get in a said company.

The securities market is highly regulated, and investors are protected by the Securities Investor Protection Act (SIPA). You can also benefit from insurance coverage by the Securities Investor Protection Corporation (SIPC). SIPC has been protecting investors for over 50 years. It has recovered billions of investors’ dollars worldwide from failed or bankrupt brokerage firms. SIPC covers up to $500,000 per individual account, including up to $250,000 for cash in over 3,500 brokerage firms. Investors can get compensated if the brokerage is a SIPC member.

Please note that SIPC doesn’t cover investors’ losses due to market conditions, wrong advice, or failed performance expectations.

Stocks, corporate bonds, indices, and ETFs are prone to unfavorable market conditions, economic downturns, and recessions. When the stock market crashes, unlucky investors get trapped unless they immediately sell stocks in free fall. Many businesses never survive the recession, leaving investors with significant losses. Thus, during the 2008-2009 recession, as many as 349 public companies filed for bankruptcy.

Nasdaq index, Russell 2000, S&P 500, and Dow Jones Industrial Average in 2008-2009. Source: TradingView.

Another example is the COVID-19 crisis. In 2020, the combined asset value of bankrupt businesses reached $292.7 billion. During the first year of the pandemic, the Nasdaq 100 and other market indices crashed as much as 26%. The good news is that market dips provide good entry opportunities. By 2021, S&P 500, Russell 2000, and other indices recovered.

Nasdaq index, Russell 2000, S&P 500, and Dow Jones Industrial Average in 2019-2021. Source: TradingView.

Stocks, ETFs, indices, and mutual funds are volatile financial instruments. They can change in value up to 20% in a year. Additionally, investors can expect the market to decline by as much as 30% every five years. Ups and downs in the stock market allow traders and investors to “buy low” and “sell high,” capitalizing substantial returns. However, investors may risk getting permanent losses as some stocks may not recover for a long time.

Although securities can beat inflation, very high inflation rates decrease real returns on investment with fixed-income financial instruments, such as Treasury bonds and municipal bonds. For instance, the U.S. 20-year Treasury bonds have a 4.3% interest rate. However, if the inflation is higher than the bond interest rate, the real return will be negative. 

The recent U.S. inflation update indicated a 3.7% rate as of 2023. Thus, for a given year, the real return on the U.S. treasury bond is 0.6%. In 2022, the inflation rate was as high as 9% in June, so inflation-adjusted T-bond returns were mostly negative.

The SPDR S&P 500 ETF Trust (SPY) recreates the S&P 500 index performance that tracks the 500 largest publicly traded U.S. companies, such as Apple, Meta, NVIDIA, and Microsoft. The S&P 500 index tracks companies from 11 sectors, including technology, financials, real estate, healthcare, and industrials. This makes the S&P 500 highly resilient in economic headwinds. If certain sectors underperform, profitable ones stabilize the index price. The index value has increased 91,700% since 1872 and 54% since 2018. It has the highest potential to beat inflation in the long run. 

Therefore, the S&P 500 ETF is the best choice for investors who want to diversify their portfolios but cannot invest in hundreds of stocks. On top of that, SPY pays 1.59% in dividends (~ $6.5 per share), complementing your portfolio with compound value growth.

The SPDR Dow Jones ETF (DIA) mimics the performance of the Dow Jones Industrial Average Index. This index tracks the 30 largest companies trading on Nasdaq and the New York Stock Exchange, such as Apple, Boeing, and IBM. 

The Dow Jones index price has increased over 110,300% since 1897 and over 30% since 2018. The Dow Jones ETF is an excellent choice to diversify your portfolio with some of the most resilient stocks. The ETF pays ~ 2% in dividends, surpassing the S&P 500 and Russell 2000.

iShares Russell 2000 ETF (IWM) mimics the performance of the Russell 2000 index (RUT). The Russell 2000 ETF gives you access to stocks of 2,000 U.S. companies with $300 million – $2 billion market capitalization. The Russell 2000 covers 100% of the U.S. equity market. It is more diversified than the S&P 500 and shows robust historical performance.

It has increased over 200% in value since 1988. Although the Russell 2000 provides higher diversification than the S&P 500, it’s more volatile as smaller companies are more prone to economic downturns. The Russell 2000 ETF pays 1.58% in dividends, providing investors with regular income atop their portfolios. Overall, the Russell 2000 ETF is a good choice for investors seeking diversification.

The Israel-Hamas escalation, Russian-Ukrainian war, and possible Taiwan conflict in 2025 drive attention to the defense sector. According to Deloitte, 88% of surveyed executives believe in very positive conditions for the aerospace and defense sector next year. The U.S. and NATO are likely to increase their military power to counter rising military threats across the globe.

The iShares U.S. Aerospace & Defense ETF, the largest industry fund, is a good choice for capitalizing on the aerospace industry. It tracks the performance of American commercial military aircraft and defensive equipment companies, including Boeing, Lockheed Martin, and Northrop Grumman. The Aerospace & Defense ETF pays 0.93% annually in dividends and provides a timely opportunity to diversify your portfolio in times of uncertainty.

Nvidia produces integrated circuits, graphic cards, and leading AI solutions. It’s a monopoly in AI technology, promising substantial gains to its stockholders in the future. As of 2023, Nvidia stock is nearly 200% up compared to its 2022 levels. 

It’s believed that Nvidia may become a forerunner of the AI revolution, and its stocks will continue to rise in 2024 and beyond. Nvidia’s AI processor chips are likely to satisfy the increasing demand from the AI sector, providing the company with consistent revenue streams. According to CNN’s Forecast, NVDA can add from 32% to 172% to its current value in the next 12 months. However, investors should bear in mind that AI stocks may see price correction when the AI hype cools down.