What Are Financial Securities?

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If you’re getting into investing, you might have come across the term financial securities. Financial securities, or securities, are tradeable assets that hold value. They’re intangible investments that can be traded between two parties.

Multiple types of financial securities exist, including stocks, bonds and derivatives. Each type has its role in helping investors diversify their portfolios, manage risk and grow their income.

Learn more about what financial securities are in finance, their role in the global economy and markets, and their importance for individual investors.

Defining Securities in Finance

Even if you’re new to investing, you probably know something about stocks, bonds, mutual funds, exchange-traded funds (ETFs) and the like. These are all types of financial securities.

Not all investments are financial securities. For example, currency, interest from a savings account and insurance policies are not considered securities. Tangible assets like a vehicle or property are also not securities.

What Are Securities?

Financial securities are investment instruments that hold value and can be traded. In finance, securities can be highly risky but with great return potential. Or they can be low-risk with minimal returns.

Take stocks for example. If you buy a stock from a start-up pharmaceutical company, you’re looking at a potentially high-risk, high-return financial security.

Mutual funds and certificates of deposit are also financial securities. The returns may not be as high, but the risk is usually much lower than picking individual stocks.

Types of Financial Securities

The main types of financial securities are:

• Equity securities: These give you an ownership position in a publicly traded company or partnership. Investors may have some control over the company’s decisions. An example is stocks. Equity securities can sometimes be volatile, making them a high-risk, high-reward option.
• Debt securities: Sometimes called “fixed-income” securities, these let you invest in a corporation or governmental body. In exchange, you typically receive a fixed amount of money back. Examples include bonds and certificates of deposit. Debt securities usually come with minimal risk.
• Derivatives: These allow individual investors to control a large quantity of assets with minimal investment. This may boost returns, while mitigating financial risk. The value of derivatives is based on the underlying asset — like a stock, commodity or bond. Examples include futures, options and swaps.

There are also asset-backed financial securities. These are backed by assets that generate income. Home equity loans and leases are two such examples.

Another type of security is the hybrid security. These combine key aspects of equity and debt securities. Examples include convertible bonds, preference shares and equity warrants.

The Types of Financial Securities

Securities in finance can be complicated, so here’s a breakdown of three of the most common types.

Stocks (Equity Securities)

What sets equity securities apart is that they give the investor ownership. Take stocks for example.

When you purchase company shares, you’re essentially receiving a small ownership percentage in that company. If you purchase 2% of all company shares, you own the equivalent of 2% of the controlling company.

Mutual funds and ETFs may also count as equity securities, but only if they primarily consist of pooled equity securities.

When you invest in equity securities — like stocks — you may gain voting rights in that company. Your actual rights, and the issues you can vote on, depend on the company and your ownership percentage.

The stock’s performance can also fluctuate wildly due to the company’s decisions, economic factors and global events. You could theoretically see great returns, but the risk may be high.

Bonds (Debt Securities)

Debt securities, like bonds, are a type of fixed-income security. When you purchase a bond, you’re essentially lending money to the bond issuer — often a government or corporation. In exchange, you receive a set interest rate over the life of the bond. Once the bond matures, you also get the initial investment back.

There are many types of bonds, including corporate bonds (like high-yield bonds), municipal bonds (like revenue bonds) and U.S. Treasuries (like long-term securities).

Bonds usually offer predictable returns. They may also be less risky than stocks, but they’re not entirely risk-free.

For example, bonds can still be subject to inflation or fluctuating interest rates. Selling a bond before it matures could lower its value. The issuer could also default on the bond.

Derivatives

A derivative is a financial security in which its performance is based on the underlying asset’s or security’s performance. Common types of derivatives include:

• Call options (stocks) — these gain value when the underlying asset does
• Put options (stocks) — these gain value when the underlying asset starts to lose value

Stock options, for instance, are a type of derivative because their values change based on the underlying stock’s price movements. Futures are also a type of derivate, one in which the contract agreement specifies when to buy or sell a specific commodity or instrument — and at what price.

Some investors use derivatives for hedging and speculation:

• Hedging: This entails offsetting an investment to try to balance the risks and returns of the underlying asset (which is backed by the derivative). This investment strategy essentially neutralizes risk.
• Speculation: This involves making educated guesses as to where the market might be headed and making investment decisions accordingly. It can be highly risky. Investors may use derivatives to take on a calculated risk with the expectation of future returns.

How to Invest in Securities

If you’re thinking about investing in securities, know that you have options. Here’s how to invest in stocks and bonds, and how to balance the risks and rewards.

Buying and Selling Stocks and Bonds

You can purchase or sell stocks through one of the following:

• Stock fund: You can purchase — or sell — blue-chip stocks, mid-cap growth stocks or large-cap value stocks via a stock fund. You can find these through investment companies. Or you can purchase them via an advisor or broker.
• Direct stock plan: Certain companies let you purchase or sell stocks directly without needing a broker. This cuts down on commission fees, but may entail plan fees.
• Discount or full-service broker: A broker can buy or sell stocks for you for a commission.
• Dividend reinvestment plan: If you already own company shares, you can reinvest any dividend payments into the company. This can potentially increase your ownership percentage.

You can’t purchase or sell bonds on a public exchange. Most can be traded over the counter (or through a broker). If you’re looking for a U.S. Treasury bond, you can get it from the government.

Understanding Investment Risks

Any investment comes with a certain level of risk. You can find ways to manage this risk yourself, or you can work with a professional advisor. Either way, be sure to weigh the options before committing your money to any specific financial security.

These are some of the biggest risks to consider when investing in financial securities:

• Volatility risk: Share prices fluctuate due to internal business changes, a faulty product, external market conditions or even political events. This makes stocks risky, especially for short-term investors.
• Inflation risk: Inflation is when the prices of everyday goods and services rises. High inflation lowers purchasing power, which is an issue for investors who receive a fixed interest rate (such as with bonds).
• Business risk: With stocks and bonds, you run the risk of a company going bankrupt and liquidating all its assets. If you have bonds, you’ll usually get paid before stockholders. Common stockholders are paid out last — assuming there’s anything left.
• Interest rate risk: The value of bonds changes with interest rate. This can have a major impact on those who sell their bonds before they mature. If the rate rises, you could receive higher returns with new bonds. If the rate lowers, you may need to sell your current bonds at a discount.

Some ways to mitigate risk include:

• Diversify your portfolio with a mix of different financial securities
• Look for FDIC-insured accounts (like CDs)
• Choose securities (like mutual funds) insured by the Securities Investors Protection Corporation (SIPC)
• Weigh your options carefully and consult the experts before making major investing decisions

Other Types of Securities

Thinking about diversifying your portfolio? Check out these other common types of securities.

Mutual Funds

Mutual funds pool money from investors to buy a variety of stocks, bonds and other securities. They offer diversification and professional management. They’re often lower-cost than other investment options. Investors can also redeem their shares — also known as liquidation — at any time.

ETFs (Exchange-Traded Funds)

Exchange-traded funds are similar to mutual funds. However, they’re traded on national stock exchanges at market prices. Two common types include index-based ETFs and actively managed ETFs.

ETFs offer a low-cost way to diversify your portfolio. They’re also highly liquid, a plus for those who need quick access to their funds.

Treasury Bills (T-Bills)

Treasury bills, or Treasury securities, are a short-term government debt security. They’re a low-risk option for more conservative investors since they’re backed by the U.S. government.

Convertible Securities

This is a type of financial security, like a bond or preferred stock, that can be converted into company shares. Convertible securities offer the potential for growth in addition to regular income.

REITs (Real Estate Investment Trusts)

Real estate investment trusts let investors invest in real estate (and sometimes related assets) without having to own and manage property. REITs generally include commercial real estate, like hotels, office buildings, self-storage facilities and warehouses.

REITs can generate income for investors. However, they lack liquidity.

Why Securities Are Important to Investors

Financial securities allow investors to turn a profit, diversify and potentially balance risk.

Diversification and Risk Management

Owning a variety of securities can help with portfolio diversification.

For example, say you own both stocks and bonds. Stocks can be highly volatile, but may have high returns. Bonds tend to pose a much smaller risk, but usually have lower returns. Having a balance of both can diversify your assets while managing risk.

Income and Growth Potential

Each type of financial security has its own income and growth potential. You can purchase multiple securities — like dividend-earning stocks and interest-bearing bonds — to grow your income.

Consider your risk tolerance and your financial goals when determining which types of securities to invest in.

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