When I began investing, one of the things I struggled with was where to start. My goal was to accumulate assets. After reading a lot, I determined that the best way for me to start accumulating assets was to invest in the market (this seemed more appealing to me than getting into real estate). Since then, though, I’ve decided to put all of my extra money onto my student loan debt and stop investing completely. BUT I still have some tips, as I’m a financial planner and I’ve learned a few general things here and there..
Introduction – Stocks, Bonds, Diversification, and Funds Defined
Stocks – When you buy a stock, you are buying a share of the company (you are now a shareholder). When you buy a stock you own one share of one company. So, if you buy one share of Apple stock, you are now part owner of Apple. (That said, you are a very very small owner!) If Apple goes under, all of your stock goes down and you lose money. (High risk; high return.)
Bonds – When you buy a bond, you are loaning money to an entity (e.g., companies or the government) for a fixed amount of time, at which point, you’ll be paid back with interest (low risk; low return).
Diversification – An investment term that describes owning a variety of securities, such as a combination of stocks, bonds, commodities, and funds. Diversification is a tool used to minimize risk. Because owning shares of one company can may be risky (if the company fails, you lose money), most people diversify their portfolios. Experts, like Marc Cuban, may not diversify (he’s spoken about how stupid it is), but for the average person, diversification is common. If one of your investments fail, you’re still in good shape.
Funds – When you buy a fund (such as an ETF, mutual fund, or index fund), you are buying a group of securities, such as stocks, bonds, and other commodities. This means you buy one fund that is already diversified in itself. A fund can be broad, where it follows an entire market (S&P 500 for example), or it can be narrow, where it follows only in a particular area (such as technology).
Mutual Funds vs. Exchange Traded Funds
If you want to invest in individual stocks and take the time to make investing a legitimate hobby of yours, you may not be interested in investing in funds. However, for people who are not making investing in stocks a hobby, investing in diversified funds is an attractive alternative. You’re able to buy the funds without having to constantly monitor them. This is a great way to invest without making investing a huge time commitment.
Mutual funds and exchange traded funds (ETFs) are two very popular types of funds that people invest in to stay diversified. Mutual funds and ETFs are similar because they are both funds that have groups of securities (100 to 3,000) in them, making the funds diversified. But which is better? It depends. Personally, I invested in ETFs through TradeKing (where the trades are only $4.95), but I’ll let you make your own decision on which is best for you. Here are the main characteristics and differences between mutual funds and ETFs.
- A mutual fund is a group of investments, including stocks, bonds, and other securities.
- Mutual funds are managed by a professional advisor at the cost of a management fee.
- The average management fee is between 0.5% and 1.0% of all funds.
- The advisor actively manages the mutual fund in an attempt to beat the market.
- While you can place an order for a mutual fund during the day, the actual trade takes place after the markets close.
- Mutual funds require a minimal investment often in the $1,000-$5,000.
Exchange Traded Funds
- An ETF is a fund with a variety of different securities in it, such as stocks, bonds, and commodities.
- ETFs are passively managed and there is no commission fee.
- ETFs track indexes, such as the NASDAQ, S&P 500, or Dow Jones or segments of the market, such as technology.
- ETFs trade like stocks on the stock exchange, with their prices fluctuating throughout the day.
- ETFs follow the market; they don’t try to beat the market.
- ETFs are relatively cheap (compared to mutual funds).
- There are over 1,300 ETFs available, so choosing which ETFs to buy requires knowing what you want in your fund.
Below is a handy chart so you can see the differences between an ETF and a mutual fund side by side.
photo by freedigitalphotos.net