With technology and a proliferation of investment products comes more decisions to make, however. There is a fund for just about anything nowadays. 50 years ago if you wanted to invest in stocks, perhaps you walked down to your bank and sat down with a banker to go through the drawn-out (and expensive) process of buying shares. Today, you turn on your phone, press a button and you’re done.
Investment platforms make it easy to see all of the choices – stocks, bonds, mutual funds, exchange-traded funds, etc. But what are these anyway? Before you open your app, you need to have the knowledge.
Stocks
Stocks are tiny pieces of equity ownership stakes in public companies. Among stocks, bonds & mutual funds, it is fair to say stocks are generally the riskiest with the most upside and downside potential. A single stock can go through the roof or go to zero. Before you buy and while you own a stock, you must do careful due diligence to make sure it is the right fit for your situation and goals.
A stock usually pays a dividend, but not always. At TFC, we like to find companies that pay solid dividend streams for our clients. Companies with good dividend policies try to keep their dividend in-tact even during tough times. Solid dividend payers have been shown to perform well compared to the overall market.
Stocks cover a range of company-types: small firms, big corporations, international businesses, various sectors & styles. The sky is the limit. Professionals use stock screening processes to help whittle-down the universe to just those equities that meet the desired criteria of the stock-picker.
Bonds
A bond is higher up in the pecking order of a company’s capital structure – what does that mean? It means the company must pay a bondholder before a stockholder. If you own a bond, you have a more valuable and safer claim on the company’s assets than a stockholder. That sounds like a good deal, but the downside is a bond can’t surge up in price like a stock can. But it also means a bond is much less likely to go to zero if times get bad.
A bond pays monthly or quarterly coupon payments to its holders and is good for a specific term. It may be a 10-year bond with a 5% coupon. That means you buy the bond for $100 and each year for the next 10 years it will pay $5 in coupon payments. They call it a coupon because way back when, you would actually have to cut out a piece of the bond (like a clipping a coupon), then mail it in! Today, it’s all electronic. At the end of the 10 years, you get your $100 back.
There are government bonds, municipal bonds (which offer a tax advantage), savings bonds, corporate bonds, high-risk bonds, low-risk bonds, international bonds – you name it! The safest are short-term treasury bills and the riskiest are high-yield junk bonds. Junk bonds are issued by companies that have poor credit ratings and are most likely to go belly-up (the upside is if they remain in business and pay off their debt, their bond investor can make a big gain). Be careful with bonds though – when interest rates go up, bond prices decline. Inflation can be a big risk.
Mutual Funds
A mutual fund is a great way for an investor who just wants to own a basket of stocks without doing a major workload of research. A mutual fund has a legal process it must follow to be transparent about what stocks and bonds it owns and what its objectives are. There are stock mutual funds, bond mutual funds, and ‘balanced’ funds with both stocks & bonds. A mutual fund is priced each day at the market close – that is the price at which an investor can buy and sell.
Do-it-yourself investors usually prefer mutual funds because they simply don’t have the time and tools to perform the necessary due diligence involved with researching and monitoring single stocks and individual bonds. Mutual funds today can be ultra-cheap or very expensive. They can have a high tax impact or low tax impact. So a lot of research is still needed even if you are a mutual fund investor.
Mutual funds also dominate the 401(k) space. You have probably seen this in your employer’s investment lineup where you must choose what set of funds you want to be in. 401(k)s today are usually filled with rather cheap index funds and some more costly actively managed products. Target-date funds are very popular too – those are the ‘set it & forget it’ funds where you pick your target retirement date, then just throw all your money into that one fund. The target date fund then evolves to be more conservatively invested as your date nears.
At TFC, we use exchange-traded funds (ETFs) in our custom-built portfolios that are tailored to our clients. We analyze the stocks and ETFs within the portfolios to ensure they are continuing to meet our objectives. ETFs generally have fewer tax implications versus mutual funds and can feature lower expenses, so we like to use them for those reasons among others.
Here’s the point
- Technology has brought about many new investment products, but stocks, bonds & mutual funds are still the big players. ETFs have grown in popularity too.
- It is easier than ever to trade these investment vehicles – but that is not always a good thing. Proper due diligence and portfolio construction are critical to be an effective investor.
- TFC uses a range of inexpensive products with professional due diligence to ensure our tailored portfolios meet the goals of our clients.
Action items
- Sit down with us to review your investments. If you are curious about your holdings, we can review how your investments fit your long-term goals.
- Keep a long-term focus. It is tempting to turn on the financial news and get all riled-up, but just know the news is in business to stir drama; not to help you as an investor.