Hammers, drills, and screwdrivers

I’m no handyman, but I am rather proud of having accumulated several dozen nice tools over the years. And on a somewhat regular basis, I use approximately three of them.

One lesson that I painfully learned early on, however, has translated well into what I do for a living: choose the right tool for the job. You don’t pound nails with a socket wrench, for example, and you don’t invest next month’s mortgage payment in technology stocks.

When it comes to investing, there are three basic tools at your disposal, and you would be wise to understand how to match them to the jobs to which they are best suited:

• Cash: By this we mean your short-term reserves: money market funds, bank CDs that come due in a year or less, bonds and other fixed-income securities with very short maturities, etc.

If you’re trying to make money grow, cash is the wrong tool for the job. Returns typically trail other types of investments, especially over long time periods. In fact, having too much in cash exposes you to inflation risk, the potential loss of purchasing power.

Cash is best suited for short-term financial goals where safety and liquidity are essential. Whatever money you set aside as an emergency reserve should be held in cash equivalents, as well as money you plan to spend for any reason over the next 12 months.

• Fixed-income: Here we are referring mostly to bonds or similar investments that pay a fixed interest rate with some promise that your principal will be returned on a specific maturity date. Bonds are issued by governments, municipalities, and corporations both in the U.S. and abroad.

While fixed-income investments come in a broad span of maturities, yields, and credit quality, they are generally considered more conservative than stocks. The interest they pay is also attractive to income-seeking investors. But safety ultimately depends on the issuer, and bond prices tend to move in the opposite direction of interest rates. If rates rise and you need to sell before the maturity date, you can lose money.

Where does fixed-income fit in your toolbox? If you have known expenses coming up in the next two to 10 years – spending in retirement, for example – I recommend matching those expenditures with bond investments of similar maturities. Fixed-income investments can also add some stability to your portfolio that might help you sleep at night, as long as you realize that lower risk often leads to lower overall returns.

• Equities (stocks): These give you fractional ownership in businesses, and all of the opportunity and risk that it implies.

Equities are most appropriate for capital appreciation, although many companies pay regular cash dividends to their shareholders, allowing them to directly participate in the success of the business. But stocks come with no guarantees: prices fluctuate, often for no discernible reason, and dividends can be reduced or eliminated.

Historically, equities have rewarded their owners with substantially higher returns than fixed-income or cash. Those returns, however, typically require more faith, patience, and time than other kinds of investments. For that reason, stocks are best suited for long-term financial goals.

The secret to keeping your home and car in working order is to use the right tool for the job – or finding the right help when you need it. Investment success begins with knowing which types of investments to use based on when you need the money.

And beware of any salesperson who would have you believe there’s one ideal investment vehicle for all of your financial needs, regardless of how nice a meal they serve you. As a wise person once said: If all you have is a hammer, everything looks like a nail.

Any opinions are those of Mike Brown Financial Group and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance is not indicative of future results.

Bond prices and yield are subject to change upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. Holding bonds to term allows redemption at par value. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rise.