What are Securities?

Quick question:

Would you go car shopping if you knew absolutely nothing about cars—how they work, how to drive one, basic features, etc.?

Probably not. How would you know what to buy if you didn’t even know what to look for in the first place?

Spoiler alert: the exact same idea applies to securities—and investing in general.

You’ve already made the first step by deciding to invest in the stock market but you probably don’t know exactly what to invest in. That’s a barrier that has to be overcome—after all, knowledge is power. 📚

The term securities encompasses more or less everything that you can invest in. We admit that we were being a bit cheeky when we told you that you’re going to be investing in securities—but there’s a reason behind that.

Right now, the world is witnessing a huge influx of new investors. Most of them have entered the markets without even knowing what securities are. They are woefully unprepared to invest responsibly—and a lot of them are going to fail. You don’t have to.

If you put in the work, educate yourself, and do some research, you can get a leg-up on the competition. We know that the finer points of difference between equity and debt securities aren’t the most enticing reading—but that knowledge will give you the confidence and expertise that you need to succeed.

Ready? Let’s jump in! 🚀

What are Securities in Finance? 🔎

Let’s start at the very beginning. A security is a financial asset that can be traded—basically, any sort of financial instrument that has a monetary value and that can be traded.

Securities are liquid assets, meaning that they can be bought and sold quite easily on public exchanges. They are also fungible—meaning that they can also be sold across different exchanges.

Securities include stocks, bonds, mutual funds, ETFs, and other, more complex instruments such as futures and options. Owning any of these securities gives you direct or indirect ownership of something—either a part of a company, a commodity, or someone’s debt.

Types of Securities Explained 🗂

Okay—we’ve explained what securities are, but it probably still sounds way too abstract and hard to comprehend. But don’t pull back—the trick is to go more in-depth. With a couple of useful examples, you’ll see that the issue isn’t all that complicated.

We’re going to cover the three main types of securities on the market, and we’ll explain it all using normal, easy-to-understand language.

Equity Securities 👇

Equity securities are the simplest and most common type of security. They represent a piece of ownership in a business, they give investors voting rights by allowing them to participate in annual meetings, and can also come with dividends—small payments that a company issues to shareholders on a one-time or regular basis.

Stocks are the most well-known type of equity security, and they’re divided into common and preferred stock. Although they are a bit more complex than stocks, ETFs and mutual funds also fall into this category as they are actually made up from multiple stocks.

Debt Securities 🧾

Debt securities encompass bonds, banknotes, and treasury notes. All of these securities are sold to retail investors with a promise of repayment, plus interest.

In practice, buying a debt security means loaning a business or the government a certain amount of money, knowing that it will be repaid by a certain date—along with a certain amount of interest that serves as profit. After all, making the government give you money for a change puts the world in equilibrium.

Debt securities are issued by governments to finance big projects, and by businesses to raise additional capital. However, all debt securities, be they government, municipal, or corporate bonds have the basic terms predetermined—the amount borrowed, the maturity, the renewal date, and the interest rate of the bond.

Debt securities are considered much safer than equity securities—but because of this, they offer far lower returns. And while it is certainly true that one of the differentiating factors between stocks and bonds is that bonds are far safer, any decently constructed portfolio should include both.

Derivatives 📄

Derivatives are securities that get their value from an underlying asset. They are also referred to as hybrid securities because they exhibit some of the attributes of both equity and debt securities.

With derivatives, you don’t actually buy the underlying asset—rather, you buy the right to buy or sell it at a predetermined price by a specific date. The easiest way to explain is by using options trading as an example.

Let’s say that AT&T’s stock is trading at $30. In this hypothetical scenario, the stock is showing some promise. But buying it at $30 is a big risk in case the stock price doesn’t end up growing. So, instead of buying shares, you buy options—the right to buy AT&T’s stock at $30 in two weeks.

If AT&T’s stock price does rise, you’ve just made a profit—you can buy it at its original price, and sell it at the new, higher price. Every options contract comes with a premium—a small fee you have to pay upfront. Because of the premium (which would probably be around $1 in this case) you won’t be able to keep the entire price difference as profit—but premiums aren’t a huge issue if you identify a good opportunity, like a sector that will outperform the market in the short term.

Derivatives also include futures, swaps, forwards, and convertible bonds. We won’t get into the nitty-gritty of these complex financial instruments in this guide, because they deserve a lot of undivided attention.

Other Popular Types of Securities 🗃

We’ve mentioned the three main types of securities—and for the most part, that’s all that you’re going to need. Other types of securities do exist, but they’re a bit more complex—we wouldn’t recommend investing in these if you’re a beginner, but it’s good to be aware of them in any case.

Marketable securities are short-term securities that businesses invest spare cash in in order to attain additional profits. Most of them have a maturity date of a year or less, and they can be either equity securities, such as common stock, or debt securities, such as treasury bills.

Fixed-income securities provide investors with a steady stream of profits. We’ve already mentioned bonds, but this category also includes preferred stock and certificates of deposit (CDs). 

Preferred stocks give shareholders regular, unchanging dividends—as such, they behave more like bonds. CDs are issued by banks—in exchange for depositing your money for a certain period of time, you’ll be able to acquire interest. However, CDs generally pay less than bonds.

Last but not least, mortgage-backed securities (MBS) are investments that are based on mortgages. MBS are made by financial institutions by bundling up a lot of different mortgages based on similar characteristics. When you buy an MBS, you buy a portion of those mortgages—and you get access to a part of the monthly payments.

Why Do Securities Exist? 💡

The main benefit that securities offer is that they make the market and the economy a lot more efficient. Securities kill two birds with one stone—they allow retail investors to make money, and they allow businesses to raise the capital they need to grow and expand.

Securities markets offer investors easy access to liquidity, as they connect investors that want to buy with investors that want to sell. They allow retail investors to make money by purchasing shares in a company, thereby supporting their future growth. 

Debt securities offer investors a chance to make small yet reliable gains by giving additional capital to companies or to make the same gains by buying state-issued or municipal bonds which generally finance large projects such as infrastructure investments. 

Whether a corporation or a government raises money this way, it accomplishes the same thing—it takes pressure away from other credit institutions, such as banks. Hybrid securities allow investors, both retail and institutional, to hedge their bets and reduce risks.

Put simply, securities offer a much simpler way for different parties that participate in the market to invest and raise money. It’s hard to overstate the huge effect that this has on market efficiency—basically, securities allow money to much more easily reach its intended destination.

How Securities are Traded 💱

Securities can be traded in a variety of ways. As a retail investor, your main source of exposure to securities will be through the secondary markets—that is, through simply logging in to your brokerage of choice and accessing the stock market.

However, that isn’t the whole story. Securities can be traded in the primary market, the secondary market, over the counter, and privately.

The primary market refers to the new issuance of stock. When a company decides to go public in order to raise money, it has to meet rigorous requirements set in place by the Securities Exchange Commission (SEC). Companies usually hire investment banks that determine how much money can realistically be raised, and, when the IPO date comes, the company’s stock starts trading at a price that is determined by the bank.

Alternatively, a company may use a private placement in lieu of an IPO—it accomplishes the same thing, but the initial offering of the stock is limited to banks, institutional investors, wealthy individuals, and pension funds. 

After that, securities are traded in the secondary market—that is your bread-and-butter stock exchange that serves as a way for investors to sell stocks to each other. The secondary market, unlike the primary market, isn’t used to raise capital—it is used by retail investors to make money via dividends and capital appreciation.

Most securities are publicly listed—but recent years have seen a dramatic increase in the number of stocks that are traded without exchanges. This method of private securities investing is referred to as over-the-counter or OTC trading, and it uses electronic communication networks to allow broker-dealers to execute trades without involving a third party.

Trading Securities Indirectly 📚

Securities can be traded indirectly by using derivatives. Derivatives are complex financial instruments such as options, swaps, forwards, and futures. With derivatives, you don’t actually own the underlying asset at any time—you’re making a bet on which direction the price of the underlying asset will move in.

The derivatives market is mind-bogglingly huge—with the upper estimates going as far as $640 trillion. Derivatives are used by institutional investors to reduce risk by hedging—but they are also commonly used by retail investors. The difference is that institutional investors can use their size to place numerous, less-risky bets—while retail investors can’t.

Derivatives offer retail investors the chance to make huge profits—however, they’re risky, and are set apart by the fact that they can end up actually costing you money. And that isn’t the only issue—derivatives have also been known to cause big, wide-reaching problems in the market.

Take the U.S. housing bubble of 2008 which started the Great Recession. A large catalyst for that catastrophic event were derivatives—specifically, CMOs or collateralized mortgage obligations. CMOs offered great returns to investors, but no one paid attention to the health of the underlying mortgages in the midst of a housing bubble.

The resulting collapse was catastrophic for retail and institutional investors alike. The problem with derivatives is that they are speculative in nature—and, unlike with equity securities, they make it possible for investors to bet against businesses.

Investing in Securities 💰

Investing in securities is rather straightforward and simple—the first thing that you’ll need to do is open an account with a broker. And while the actual process of opening an account takes only a small amount of time and can be done entirely online, choosing a broker isn’t quite so simple.

Choosing a Broker ✅

Brokerages vary, but most fall neatly into one of two categories: full-service brokers and discount brokers. While full-service brokers offer a wide variety of services, such as financial planning, retirement advice, and access to financial advisors, they require higher investment minimums and usually charge a percentage of assets under management as a fee.

Discount brokers, on the other hand, don’t offer as wide an array of services—but they’re much cheaper, more accessible, and charge flat fees for each transaction. Their minimum investment requirements are generally quite low, meaning that most of the best brokerages for beginners fall into this category. In fact, here are a few popular brokers for newer investors:

Knowing how to choose a good brokerage entails a lot of criteria which we won’t go in here—but as far as the topic of securities is concerned, you’re going to have to focus on the range of investment opportunities that a broker offers.

Simply put, not all brokers offer equal access to the market—while some offer both stocks, ETFs, bonds, options, and even cryptocurrency, others only offer one or two asset classes. Picking a broker with a wide range of investment choices is paramount—you don’t want to end up switching brokers down the line.

Another key factor to consider is the ease of use. Brokerage platforms vary in accessibility how user-friendly they are. If you’re a beginner, focus on finding a broker that offers a reliable, easy-to-use platform—along with a great stock trading app.

Purchasing Securities 🤝

After you’ve selected a brokerage, opened an account, and put some money into it, it’s time to start investing. The first thing on your list should be deciding what you’re going to invest in.

If it’s going to be your first rodeo, stick to the basics—start off slow and steady by investing in a couple of stocks and some ETFs. These are simple, safe securities that will allow you to familiarize yourself with the process of investing without too much risk by constructing a small, sensible, meat-and-potatoes portfolio.

You’re going to have to do some research if you want to become a successful investor. Learn how to read a stock chart, and start learning how to make your way around a financial statement. Familiarize yourself with investing terminology.

Once you’ve covered the basics, it’s time to learn about stock researching. You’re mostly going to be relying on fundamental analysis when it comes to stocks and ETFs, but later down the line, if you decide to invest in derivatives, knowledge of technical analysis is also quite handy.

If you’ve got the extra income to spare, the process of researching stocks and finding trading opportunities can be expedited by investing in some stock analysis software or a top options trading alert service—but keep in mind that both of these options still require you to do the legwork and understand the information that is given to you.

Once you’ve decided to purchase a security, you’re going to place a market buy order. This will buy the security in question for roughly the price that it is listed at—but there’s always a small difference. You’ll learn more about order types later on. For now, pat yourself on the back—you’ve just bought your first security.

Is it a Good Idea to Invest in Securities? ⚖️

Here we come to the most important question of all—after all that you have to go through to understand this stuff, is investing in securities actually worth the trouble in the end?

Let’s get one thing straight right off the bat—investing in securities comes with risk. You aren’t guaranteed to make money, and, in fact, you’re likely going to lose some in the process. But investing your money in this way is worth it—and that’s a statement that’s supported by data.

Other than securities, your only other option more or less is to put your money in a savings account. Sounds good, right? After all, that money is safely stored away, you earn interest on it, and there’s no risk, right?

Wrong—even the most appealing savings accounts offer returns that generally can’t keep up with inflation. In effect, this means that by putting your money away in a savings account, although the number of dollars you’ll end up with in a few years’ time will be bigger, the actual value or purchasing power of that money will have diminished.

The stock market offers a much better average rate of return of around 9% – 10% per year. Although risk is involved, investing in or trading securities isn’t gambling—with time, patience, and research, you can minimize the risks, and make sensible investment choices that you’re comfortable with. In fact, the S&P 500 keeps hitting record highs even now, and that means that the markets are still profitable overall.

Barclays’ UK-based Equity Gilt Study looked at the performance of savings accounts versus investing in the stock market. The results are overwhelmingly in favor of the stock market and only become more favorable as your investment horizon expands.

Simply put, when all is said and done, investing in securities will still be a much better option for the vast majority of people—whether they’re saving up for retirement, a new home, or any major investment.

The Good and the Bad with Securities

How are Securities Made? 🦜🐝

The primary way in which securities are made is an initial public offering or IPO. When a company decides to go public, it hires an investment bank to work out a plan—in essence, to figure out how much money should be raised. 

Once that is determined, the bank also decides how many stocks to issue, and in doing so, what the initial price will be. Once that is done, the specified amount of shares is created.

Stocks can also be created by a stock split. A stock split is an event where a company divides shares that are already on the market into multiple shares. To use a simple example, if a company decides on a 3-1 stock split, and you own 10 shares, after the split, you’ll own 30. 

Companies do this to reduce the price of individual shares, to lower the barrier toward investing so that more people can buy their shares. Although new shares are created, the overall value of your investment won’t change. Stock splits are rare, but seeing as how stocks are quite expensive as of late, they might become a more common occurrence.

The number of available stocks can also be increased by a dilutive secondary offering in which additional shares are created and put on the market.

When it comes to options, retail investors can write their own option contracts—but that requires quite a hefty amount of capital, meaning that it is out of reach for most beginners.

How are Securities Regulated? 👩‍⚖️

Securities are investments that carry risk, and some of them are quite complicated financial instruments—so it comes as no surprise that they have to be highly regulated. This task falls to various government agencies, commissions, and other bodies—but the market also has plenty of self-regulatory organizations.

In the U.S. the main governing body with regard to securities is the Securities and Exchange Commission (SEC). It enforces regulations, punishes fraud, and sets the standards that brokerages have to fulfill in order to operate on the market. 

The SEC also provides information to retail investors, offers legal protection and support in certain cases, and oversees the Securities Investor Protection Corporation (SIPC), which offers investor protection in the form of insurance in case a broker goes bankrupt.

The SEC is supplemented by self-regulatory organizations such as the Financial Industry Regulatory Authority (FINRA), the National Futures Association (NFA), and the National Association of Securities Dealers (NASD).

Other segments of the market are regulated by dedicated government agencies, such as the Commodity Futures Trading Commission (CFTC) and the Treasury Department’s Bureau of the Public Debt, which regulate commodity futures and bonds, for example.

Other countries, of course, have their own regulatory bodies. The United Kingdom’s chief regulator is the Financial Conduct Authority (FCA), while Australia has the Australian Securities and Investments Commission (ASIC), which just recently cracked down on three companies for failing to lodge financial reports.

Most regulatory bodies in countries with developed economies work in the same way and have the same goals—to ensure transparency, ethical business, and offer regulatory frameworks that support an efficient and thriving market, as well as to protect investors.

The Bottom Line

If you’ve made it this far—congratulations! We know this isn’t exactly the most interesting part about investing, but that commitment will take you far. Although this knowledge of securities isn’t too practical on its own, it serves as a bedrock and foundation for furthering your skills as an investor.

This stuff is a bit heavy—so don’t hesitate to return to this guide when needed. Absorb this knowledge and think about what type of investments you’d like to make—as you’ve seen, securities can differ quite a lot from one another. Most investors start off with equities—but who knows—you might end up a successful derivatives trader one day.

Just keep at it! 💪