What Goes Up, Must Come Down
I think it’s time for us to touch upon INVESTMENTS! There are so many different investment types and investment vehicles out there. But let’s all be honest, the average investor really has the same type of investments in their portfolio. Most people have heard all of the below terms before, probably hundreds or thousands of times, and I constantly come across people who don’t know what they are. So.. here you go.
Stocks (or equity)
A stock is a share of ‘ownership’ that is issued by a Company to raise funds. Stock represents a claim on the company’s earnings (and losses). Many people confuse owning shares of a company with actually owning a piece of the company, this is incorrect. The chairs and tables at the corporate office still belong to the corporation – not to the shareholders. Owning stock gives you the right to vote in shareholder meetings, receive dividends (which are the company’s profits) if and when they are distributed, and it gives you the right to sell your shares to somebody else.
If you own a majority of shares, your voting power increases so that you can indirectly control the direction of a company by appointing its board of directors. Not so relevant to the average person, but very relevant when a company buys over another company.
Stocks are issued by companies to raise capital in order to grow the business. By buying shares of the company, you’re essentially betting that you will make money because the company will grow or profits will increase. Just keep in mind, companies don’t always grow, and very often they go bust – so you know, you’re risking losing all of your money as well.
Bonds are fundamentally different from stocks. Bonds are a personal loan that purchasers of bonds are giving to a company, government, or municipality. Bondholders are creditors to the corporation, municipality, or government, and are entitled to interest as well as repayment of principal. Creditors are given legal priority over other stakeholders in the event of a bankruptcy and will be made whole first if a company is forced to sell assets in order to repay them. This inherently makes them significantly safer, and less risky, than stocks. Shareholders are last in line and usually receive nothing, or a few pennies, in the event of bankruptcy.
On the flip side, bondholders are ONLY entitled to receive the return given by the interest rate agreed upon by the bond, while shareholders can get great returns generated by increasing profits, theoretically to infinity.
Bonus point: many municipal and government issued bonds are tax advantaged. For instance, a New York City (NYC) resident owning a NYC school bond will pay not taxes on the interest received from the bond.
A Mutual Fund is an investment vehicle made up of a pool of monies collected from many investors for the purpose of investing in securities, such as stocks, bonds, money market instruments, and other assets. Mutual funds are operated by professional money managers, who allocate the fund’s investments and attempt to produce capital gains and/or income for the fund’s investors. A Mutual Fund will usually have a stated investment objective and as such, the investments are made to align with the stated objective.
When thinking about how these operate- just remember – MUTUAL. All the expenses are shared, all the costs are shared, all the gains are shared, and, of course, all of the losses are shared. The amount of each that a shareholder of the fund will experience is directly proportional with the amount of the fund that the shareholder owns. When you buy a share of a mutual fund, you are actually buying the performance of its portfolio.
A mutual fund is both an investment and an actual company. This is strange, but is actually no different than how a share of AAPL is a representation of Apple, inc. When an investor buys Apple stock, he is buying part ownership of the company and its assets. Similarly, a mutual fund investor is buying part ownership of the mutual fund company and its assets. The difference is that Apple is in the business of making computers and smartphones, while a mutual fund company is in the business of making investments.
Exchange Traded Funds (ETF)
An ETF is a type of fund that owns the underlying assets (shares of stock, bonds, oil futures, gold bars, foreign currency, etc.) and divides ownership of those assets into shares. Shareholders do not directly own or have any direct claim to the underlying investments in the fund, but they do own these assets indirectly. ETF shareholders are entitled to a proportion of the profits, such as earned interest or dividends paid, and they may get a residual value in case the fund is liquidated. The ownership of the fund can be easily bought, sold or transferred in much the same way as shares of stock.
An ETF is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike Mutual Funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes through the day as they are bought and sold and typically have higher daily liquidity and lower fees than mutual fund shares.
By owning an ETF, investors get the diversification of an index fund as well as the ability to sell short, buy on margin, and purchase as little as one share (there are no minimum deposit requirements). The expense ratios are significantly lower than those of the average mutual fund.
There are like 23074896237894678236 different types of investments and investment vehicles out there by these 4 are usually the core of any diversified portfolio and the core of most newspaper articles out there. So now when someone talks about Mutual Fund expense ratios in Investment News, you know a little more about what they’re referring to and why it matters.