The financial system is referred to quite a bit in the news. It is the group of investing, financial institutions and markets institutions in an economy that help to match people and firms that have excess financial capital with people and firms looking to borrow or raise financial capital. If we borrow money to buy a house, car, or through credit cards, we’re making use of this system. There are two basic types of institutions in the financial system: we’ve got financial intermediaries and financial markets. Financial intermediaries are institutions where funds are transferred INDIRECTLY between parties. So, for example, a bank is a financial intermediary. You make deposits at your bank. Other individuals come ask for loans at the bank and the bank does the ground in the middle. So, they match you with your excess funds with someone who wishes to borrow funds, and the bank does the transaction.
Investing, Financial Institutions and Markets
We discuss a lot about banking institutions in the Savings Unit. So, we’ll move on to the other common type of financial intermediary, investing, financial institutions and markets and a mutual fund. This is an institution that buys an assortment of stocks and bonds (called a portfolio) and then sells shares of the portfolio to the public. You are not directly choosing the stocks and bonds and not directly buying them, a mutual fund is a financial intermediary going between you. The stocks and bonds. Here’s why many people invest in mutual funds.
Let’s suppose you have $500 you’d like to invest, and you purchase one company’s stock. Now, if that company does well, the stock goes up in value, you’ve made a good investment. If that company does poorly, you lose money. It’s kind of like putting all of your eggs in one basket when you buy only one company’s stock. So here’s where mutual fund comes in. They allow you to diversify your investment because you are buying a share of a portfolio that’s invested in many stocks. So, some of the stocks will be going up and some of the stocks might be going down, but on balance you should be able to come out. Another reason people like mutual funds is because they don’t have to follow individual stocks to track their investment. If you don’t want to take the time to learn about individual stocks, you can buy a mutual fund that will buy those stocks for you. I think very convenient. You add safety to it because you’re diversified in many different stocks. You’ve got a manager that’s hired to buy those stocks for you, to pick and choose, so you don’t have to know much about it. Professional investors manage mutual funds and are the ones tracking stocks and bonds and deciding when to buy or sell. All you have to do is select the mutual fund you want to buy and how much you want to invest.
Unlike your savings account, a mutual fund is not FDIC insured. That means you are not guaranteed to get your money back. But There is a higher risk, you’ll actually earn a higher return – or at least you could. Now this is something important to keep in mind. If you’re earning a higher return it’s because you’re being compensated for taking on more risk. If you ever hear of an investment that has a great rate of return and has no risk – it is NOT a “sure thing.” Financial markets are institutions where funds are transferred directly between parties. The two most common types of financial markets are the stock market and bond market.
If you want to buy a stock, you can just go online and buy one. Same thing with bonds. You are making your transaction directly with the stockholder or bondholder. Sure, a 3rd party might actually facilitate the transaction or transfer of funds – when we say the funds are transferred directly, we mean you are choosing the stock and when to buy it. Someone isn’t doing that part for you..