An investment is an item or asset acquired with the hope that its value increases over time to generate income. While there are several types of investments in accounting, the three main types are stocks, bonds and mutual funds. The accounting team at GCS Malta discuss these types of investments in this article.
The 3 main types of investments in accounting:
Stocks
Stocks represent partial ownership or equity in a company. When buying stock in a particular company, the purchaser will become a shareholder and be entitled to a part of the company’s profits. If the company performs well, the value of shares will most likely grow over the years. Similarly, if the company performs poorly, the value of shares will decrease. Typically, companies who own shares in other companies sell these shares to generate profit or sometimes even to improve the cash flow position of the business.
Bonds
Bonds are a loan to a company or government. Bonds are issued for a specific period of time during which interest payments are made to the bondholder. The amount of these payments depends on the interest rate established by the bond issuer at the issue date, i.e. the coupon rate. At the end of the maturity date, the bond issuer must repay the original bond amount.
Compared to stocks, bonds are considered a more stable investment since these usually provide a steady flow of income. However, one drawback is that long-term return is generally less than stocks. This is because bonds generate cash differently, usually through regular interest payments.
Bonds have an inverse relationship in terms of price. This means that when stock prices rise, bond prices fall and vice-versa.
Diversifying investments between stocks and bonds in a business highlights the safety of the bonds with a possible higher return of stocks and ensures a proper capital structure.
Mutual funds
A mutual fund is a pool of several investors’ money invested broadly in several companies. If the funds sell securities which have appreciated, the fund realizes a capital gain. The risk here is minimized since investments are diversified. However, these funds charge annual fees or commissions which affect overall returns. Such funds will usually have a fund manager or investment adviser, who is obligated to work in the best interests of mutual fund shareholders.
The price of a mutual fund is referred to as the net asset value per share, which is calculated by dividing the total value of securities in the portfolio by the total amount of outstanding shares.
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