Corporate stocks represent ownership in a company, the stock’s price is a representation of how valuable it is according to public opinion. If a company is expected to not do as well as hoped, stock prices will go down as people sell off them off. If the company does a lot better than expected, then the stock price goes up as more people buy them. If there is bad news about the company, then the stock goes down. If there is good news about the company then the stock goes up. This is the way of stocks.
Therefore, it’s not a bad idea to think of the prices of stocks as the expectations of the company. Strong prices tell you people expect it to do well while weak prices mean the opposite. And if you disagree, you can buy the stock in expectations that the price will go up or you can short the stock in expectations it will go down. Shorting simply means you’re borrowing shares and selling them, expecting they will be cheaper to buy back in the future. Not only can you short stocks, you have a million other contracts you can have to make money such as options, which is a contract that sets a price that you can either buy or sell a certain stock for at a subsequent time.
· Higher Returns - Stocks typically have the potential for higher returns compared to other types of investments over the long term
· Pay Dividends - Some stocks pay dividends, which provide extra income or used to buy more shares
· Volatile - Stock prices can swing dramatically from high to low meaning your gains today may be gone tomorrow based
· Uninsured – stocks are the unsafest of all investments as they can become worthless quickly based on investor opinion and if the company goes bankrupt
Next up is corporate bonds. Corporate Bonds is debt issued by a company, and are very similar to government bonds except they aren’t as safe. But because they aren’t as safe, they usually pay out more interest than government bonds. Because when investing, the interest on a debt represents the risk of the investor, called a risk premium. Therefore an investor should be paid more for taking on more risk. Thus, the more creditworthy the company, the less interest it will pay because of the lesser risk. This is not only how corporate bonds work, but all loans from mortgages, auto-loans, and personal loans such as payday loans and even pawn shops. All loans’ interest is calculated based off of how risky the borrower is. The more likely you expect someone not to pay you back, the more interest you will charge to compensate you for taking on the risk.
· Pay Higher Interest - Corporate bonds usually pay more than government securities, money markets, and CDs, especially if they are risky bonds
· More Risk - The Company that issued the bond could suspend interest payments, or even go out of business
· Commissions - You may have to pay a commission to purchase corporate bonds and affecting your ROI
· Penalty for Cashing in Before Maturity – cash out before the bond matures, and you may not get back all of your original investment.
Money Market Funds
Money market funds combine a checking account with a mutual fund. When you put money in a Money Market fund, you have all the benefits of a checking account such as high liquidity and the ability to write checks. But while your money is in the account the fund invests it in highly liquid, safe securities such as certificates of deposit, government securities, and commercial money. Meaning you’re making with your money, but because its invested in highly liquid assets that if you want to use your money, you can.
- Liquid – gives you access to your money through both ATMs and checks
- Higher Interest – although they are safe, they have more inherent risk which is why they pay out more interest than other accounts.
- Safe – legally required to keep the price per share near $1, making it safer than other mutual funds, but not normal accounts
- Not FDIC Insured – because they are purchased through brokers and mutual funds, they are not insured
- Negative Interest - No guarantee that the price per share will remain at $1. Meaning your money is losing value rather than gaining value in your account
Bond funds are mutual funds that invest exclusively in Bonds and purchase large swathes of different bonds to diversify and protect your portfolio.
· Diversified – owns a little bit in every bond market to minimize risk from one or two bad bonds
· Balanced Interest – Because the bonds are in many different markets that have varying interest rates, you can have a higher interest rates than just buying only one bond in one market
· Fluctuating Yield – being a mutual fund, the yield will change depending on interest rates, buy/sell costs, and other factors that are outside your control. So you never know how much you are going make until you cash out
· Management Fees - You will pay ongoing management fees, which is fine as long as they make more money than they charge you, as some of the best managers will take all your profits for themselves
· Commissions – the bane of the financial industry, paying someone to sell you a certain fund. Whether or not the fund is any good for your goals
Mutual Funds come in a variety of flavors and each have their own risks and returns. But essentially, you just have to think of them as a basket that holds multiple investments. This basket could have individual stocks and bonds in it or can even have other mutual funds or ETFs. The idea behind them is that you pay someone a management fee to fill the basket for you so you don’t have to do it yourself. And of the many flavors, here are the major six you will see on the market.
1. Fixed income funds - These funds fill their basket with investments that pay a fixed rate of return. Usually, government bonds, investment-grade corporate bonds, and high-yield corporate bonds. The purpose of these funds for most people is that they want a guaranteed return on their money so they can sleep well at night.
2. Equity funds – Equity funds fill their basket with stocks. Unlike fixed income funds, these funds aim to make more money over time by taking on higher risk. These could be growth stock funds that make their money on investing in companies they are expecting to grow quickly over the next few years to sell for a hefty profit at the end. Income funds that pay large dividends and are for people who want cashflow while they own the fund.
3. Balanced funds – These funds fill their basket with both fixed-income and growth stocks to try to capitalize on the benefits of both.
4. Index funds – To understand an index, you have to think of it as a very, very large mutual fund that covers a lot of companies in an industry. Although the index is made up, their purpose is to show how well a specific industry is doing within the economy. This could be blue-chip stocks that represent the largest and most established companies, the tech industry that is populated with many tech companies, and any other index of companies that can make up an industry.
Therefore, the mutual fund that follows an index, fills its basket with stocks that best replicate the return you’d get if you had purchased all the stocks in the index. (Usually cheaper because management doesn’t have to work as hard)
5. Specialty funds – these funds could also be called “Niche Funds” as they focus on their basket with specialized investments such as real estate, commodities, or any other niche they specialize in.
6. Fund-of-funds – These mutual funds could be called “Meta-Funds” as they invest only in other funds. Essentially, they fill their basket with funds they believe know what they are doing and getting great returns. Piggybacking off their success.
· Don’t Need Plugged In – if you have ever traded stocks, you know at times you have to be plugged in 24/7 to make sure your investment is doing well. This includes reading quarterly and annual financial reports. Deciphering what the company is really saying and making a decision to hold or sell. Putting your money in a mutual fund makes all that the manager’s job, leaving you to enjoy your free time.
· Different Flavors to Choose from – Mutual funds have an option available for nearly anyone’s investment goals. If you want fixed-income, there is a mutual fund for that. You want to take on higher risk for a higher return, there is a mutual fund for that. If you want a combination of the two, there is a mutual fund for that.
- Diversified – can own a little bit in every market to minimize risk from one or two bad investments
- Higher Risk – depending on the mutual fund you
- Management Fees - You will pay ongoing management fees, which is fine as long as they make more money than they charge you, as some of the best managers will take all your profits for themselves.
- Hidden Fees - Also be wary of the addition of hidden fees they like to sneak in. Mutual Funds are notorious for getting you in the fund and sneaking additional fees afterwards. Although they are legally required to tell you about these fees, they sneak them in the reports they mail to you, expecting you won’t read it anyway.
- Commissions – the bane of the financial industry, paying someone to sell you a certain fund. Whether or not the fund is any good for your goals. Be careful on who is advising you and what their true motives are.
ETFs (Exchange Traded Funds) are exactly like a mutual fund in that they are a basket of investments such as stocks and bonds and are managed by a manager who decides what those investments will be. The only major difference is that an ETF is treated like a stock in the way it is bought and sold compared to a mutual fund. As a mutual fund cannot be bought and sold, it can only be invested in or out. This means that an ETF can be bought and sold on the stock market, can be shorted and optioned, and anything else you can do with a stock.
· More Readily Traded - Traditional mutual fund shares are traded only once per day after the markets close meaning you can’t speculate on the fund to go up or down in price for a profit. While ETFs are traded all day like a stock.
· Cheaper than Mutual Funds - streamlined compared to mutual funds as the costs are put on the brokerage instead of the investor. Making less overhead that equates to more investor returns as they don’t have the legal requirements of having a call center for questions or the need to send out monthly reports.
· Tax Benefits – mutual funds have more capital gains taxes than ETFs because mutual funds have to pass on the costs of every trade before a year to the investor, while ETFs are only taxed when they are sold.
· Quickness of Buy/Sell – because it’s sold as a stock, this makes it easier to buy and sell to gain exposure to certain industries. You could get the same result by having a mutual fund, but because mutual funds are designed mostly for long-term investors, it can be a process to get in and out of them.
· More Expensive than Anticipated – because the costs are baked into the stock, it can be hard to tell if you’re really getting a deal or not.
· May not make sense for the Long-Term Investor – due to the nature of how it is traded, it may not make sense for a long term investor who wants to hold onto his investment for years to come. The benefits of being a stock are not utilized for some long-term investors
The last offering from the brokerage and corporate world is ADRs (American Depository Receipt). This were introduced as an easier way for U.S. Investors to invest in foreign companies. As the bank would purchase a large lot of shares from the company, bundle them into groups, and reissue them in US currency. Although you don’t have to invest in ADRs and you can invest in foreign companies yourself, you’d have to set up a brokerage account and watch the exchange rate as you move in and out of currencies. Making things complicated quickly.
· Don’t Need Foreign Brokerage Account – the biggest pro of ADRs is having the ability to buy stocks in foreign countries with your normal brokerage account. This takes the hassle of having to set one up in the country you want to invest
· Automatically Calculated Exchange Rates – because the bank calculates the exchange rate for you, you can follow the prices of the stock based on your currency and not the foreign companies
· Diversify your Portfolio – allows you to expose your portfolio to other countries and companies that can increase your return.
· Political Risk – with the purchase of an ADR, you now have vested interest in the politics of that country because the government could decide to expropriate the company or your investment.
· Exchange Rate Risk – may have to be mindful of the foreign companies’ currency, although your ADR is calculated in your currency, strengthening and weakening of the foreign currency and affect the returns you receive.
· Inflationary Risk – if the government is very poor with their finances, they may print more money and cause inflation. High inflation can make the company becomes less and less valuable each day and your investment worth less and less.
There you have it. Here are the most common offerings from the corporate/brokerage world. Being they are backed by private organizations and individuals, they are the riskiest of all investment as they are not protected from scandal, bankruptcy, or bad business practices. Meaning you need to be careful and understand that with the higher return your expecting, carries with it a higher risk of losing your investment. With that said, INVEST WELL and with DUE DILIGENCE. As they can only get it past you, if you let them.