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Saving & Investing for Beginners: Financial Institutions

Updated on March 14, 2008

The financial system in the United States is made up of many different types of financial institutions that coordinate money between savers (people who spend less than they earn) and borrowers (people who spend more than they earn). People save for different reasons, like to put a child through college someday or to retire comfortable in the future. At the same time, borrowers borrow for many reasons—to buy a house or start a business. Savers supply their money to the financial system expecting they will get it back with interest later. Borrows receive money from the financial system knowing they will pay it back with interest at a later date.

Different financial institutions juggle the coordination of the savers’ needs and the borrowers’ needs. There are two categories of financial institutions: financial markets and financial intermediaries. After you learn more about them, you will be better at making your financial decisions.

Financial Markets

These are the institutions through which people who want to save money can supply funds to people who want to borrow. The two important markets are the bond market and the stock market.

The Bond Market: Companies can borrow money from the public by selling bonds. A bond is an IOU between the borrower (company) and holder of the bond (investor). The bond specifies when the loan will be repaid (date of maturity) and the interest rate that will be paid until the bond matures. If you hold a bond, you can keep it until maturity or sell it to someone else before the maturity date. Selling bonds is called debt finance. Owners of bonds are creditors of a company.

The Stock Market: Companies can raise money by selling stock in their company. Stock represents ownership in a company. If a company sells 1,000,000 shares of stock, then each share represents 1/1,000,000 ownership of the business. Selling stock to raise money is called equity finance. Owners of stocks are part-owners of the company. Stocks sold to the public are traded on stock exchanges.

Stock

  • Owners are part-owners
  • If company is profitable, stockholders enjoy profits
  • If company runts into financial difficulties, stockholders may not receive any profits
  • Higher risk, possible higher return

Bond

  • Owners are creditors
  • If company Is profitable, bondholders only get fixed interest
  • If company has financial difficulty, bondholders are paid what they are due
  • Less risk, stable returns

Financial Intermediaries

These are institutions through which savers can indirectly provide funds to borrowers. These institutions are the intermediaries that stand between savers and borrowers. The two important financial intermediaries are banks and mutual funds.

Banks: A bank’s primary job is to take in deposits from people who want to save and use them to make loans to people who want to borrow. Banks pay interest on deposits and charge slightly higher interests on loans. The difference between the interest rates covers the banks’ costs and creates some profit.

Mutual Funds: A mutual fund sells shares to the public, and then uses the proceeds to buy various types of stocks, bonds, or both stocks and bonds. The shareholder of the mutual fund accepts all the risk and return; so, if the value falls, the shareholder suffers loss, but if the value rises, the shareholder benefits. Mutual funds allow people with small amounts of money to diversify their investments. They make it easier for people to invest without spending a lot of money. As well, mutual funds are managed by professionals, so an investor receives the benefits of buying into a well-managed portfolio.

Beyond the Basics

There are a large variety of financial institutions in the U.S. economy besides these basics, like pension funds, credit unions, insurance companies, and even loan sharks. But when you are first starting to invest, it is a good idea to stick to the basics to learn the ropes. As you continue to learn about investing, you can start to branch out. You should consider talking with a financial planner about your options, which will give you the opportunity to ask any questions you may have.

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    • monicamelendez profile image

      monicamelendez 

      6 years ago from Salt Lake City

      The difference in deposit interest at a bank and loan interest is pretty dang huge, especially since most banks pay out less than .5% on checking or savings accounts.

    • anna.smith profile image

      anna.smith 

      7 years ago from Germany

      Vry Useful information..

    • profile image

      Denny Lobach 

      7 years ago

      Well done article. Good outline of choices available for beginners.

    • crstofr profile image

      crstofr 

      8 years ago from Orlando

      Excellent Article. It is a scary time for the first time in history Corporate Bonds are better bets than many Sovereign Bonds ( Countries). I'd be very careful about buying Municipal Bonds now too, especially from places like California, NY, NJ, & Illinois.

    • jumbocd profile image

      jumbocd 

      8 years ago from Sacramento Area, CA

      Nice article. Nice scores, too. One thing to point is that Corporate Debt and stocks are only good as the company backing them. If a company defaults, large amounts of money can be lost. So make sure your investments are with solid companies.

      cd :O)

    • Neil Ashworth profile image

      George Poe 

      8 years ago from United Kingdom

      Great !! I've bookmarked this for further viewing..

    • ezzy1512 profile image

      ezzy1512 

      8 years ago

      Well informed piece.

    • profile image

      Steve Nichols 

      8 years ago

      With Ron Insana's new book encouraging investing in this down economy, I think more people will be interested in getting involved in the stock market. Your hub is very helpful.

    • profile image

      james Emery st. Louis 

      9 years ago

      how does the shadow Monetary government fit into all this? can anybody answer that?

    • profile image

      nazishnasim 

      9 years ago

      Very informative indeed.

    • Kat07 profile image

      Kat07 

      10 years ago from Tampa

      Stacie - Wonderful info! Thanks! Saving for retirement or investing is so challenging when living pay-check-to-pay-check with loads of unexpected expenses - wonder how to make pennies into dollars with these strategies?

    • Eileen Hughes profile image

      Eileen Hughes 

      10 years ago from Northam Western Australia

      Very good information. I tried the stock market in little investing. We all need to be careful if do not know all the details. And spread money around never put all in one place as too risky

    • beachbum_gabby profile image

      beachbum_gabby 

      10 years ago

      well done and very informative hub Stacie. I'm into financial too, I would like to invite you to my hubs. Thank you. :)

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