There is more to life than money, but you need to know how to invest it wisely. Don’t be scared of lack of knowledge, as that will not be a problem once you read this article. Read this article to learn what you need to know.
If you want to invest in the stock market but don’t have a large enough portfolio to achieve the diversity you want through individual stock purchases, mutual funds may provide the solution you are looking for.
Mutual funds are a collection of stocks designed to meet a stated investment objective or strategy. For instance, you may be able to choose between a fund that holds small- or mid-sized companies, large blue chip companies, or government bonds. Some funds are designed to provide growth, others to give you income.
Fully diversified mutual funds can offer you dozens and sometimes hundreds of individual stocks or bonds. Achieving a similarly diversified portfolio by purchasing individual stocks is more difficult and costly. The trading costs for buying and selling stocks can quickly eat away a smaller portfolio’s value. This is less of a problem if you have a larger sum of money to invest.
Understanding the Risks
Mutual funds provide a stated objective or strategy, giving you some understanding of the level of risk and the potential for return. You can get an understanding of the fund’s objective and past performance by reading its prospectus. But a fund’s stated objective may not tell you the whole story.
Many funds have a great deal of latitude in which stocks they may actually buy. Therefore, even if you own shares of six different funds, each supposedly invested under a different type of overall objective, you may not be as diversified as you think. Each of the six funds may hold shares of the same stock. This would increase your vulnerability to market corrections, even though you may not be aware of the risk.
A mutual fund’s performance depends in large part on its portfolio manager. So, what happens if the fund’s manager changes his or her strategy during the investment period or the fund changes managers? Having an investment advisor who meets regularly with the fund’s manager to determine his or her strategies and meets with the fund company to determine its policies for hiring and maintaining quality portfolio managers can help you minimize this risk.
Reading a Mutual Fund Prospectus
A mutual fund prospectus should outline these six factors that allow you to evaluate the fund and its potential place in your plan.
1. Investment objective. Is the fund seeking to make money over the long term or to provide investors with cash each month? You’ll find the answers in this section of the prospectus.
2. Strategy. This section should spell out the types of stocks, bonds or other securities the fund plans to invest in. It may look for small, fast-growing firms or large, well-established companies. If it’s a bond fund, it may hold corporate bonds or foreign debt. This section may also mention any restrictions on what the fund can invest in.
3. Risks. The prospectus should explain the risks associated with the fund. For instance, a fund that invests in emerging markets will be riskier than one investing in the United States or other developed countries. A bond fund should also discuss the credit quality of the bonds it holds and how a change in interest rates may affect those holdings.
4. Expenses. Different funds have different sales charges and other fees. The prospectus will spell out those fees so you can compare them with the fees of other funds. It should also explain the percentage of the fund’s return that is deducted each year to pay for management fees and operation costs.
5. Past performance. Although you shouldn’t judge a fund solely by its past performance, this can show how consistently the fund has performed and give some indication of how it may fare in the future. This section of the prospectus will also show you the fund’s income distributions and its total return.
6. Management. This section may do nothing more than list the fund manager or managers, or it may give specific information about the management team’s experience. If the prospectus doesn’t contain enough detail, you may be able to find this information in the fund’s annual report.
Overall, there are three different kinds of investments. These include stocks, bonds, and cash. Sounds simple, right? Well, unfortunately, it gets very complicated from there. You see, each type of investment has numerous types of investments that fall under it.
There is quite a bit to learn about each different investment type. The stock market can be a big scary place for those who know little or nothing about investing. Fortunately, the amount of information that you need to learn has a direct relation to the type of investor that you are. There are also three types of investors: conservative, moderate, and aggressive. The different types of investments also cater to the two levels of risk tolerance: high risk and low risk.
Conservative investors often invest in cash. This means that they put their money in interest bearing savings accounts, money market accounts, mutual funds, US Treasury bills, and Certificates of Deposit. These are very safe investments that grow over a long period of time. These are also low risk investments.
Moderate investors often invest in cash and bonds, and may dabble in the stock market. Moderate investing may be low or moderate risks. Moderate investors often also invest in real estate, providing that it is low risk real estate.
Aggressive investors commonly do most of their investing in the stock market, which is higher risk. They also tend to invest in business ventures as well as higher risk real estate. For instance, if an aggressive investor puts his or her money into an older apartment building, then invests more money renovating the property, they are running a risk. They expect to be able to rent the apartments out for more money than the apartments are currently worth – or to sell the entire property for a profit on their initial investments. In some cases, this works out just fine, and in other cases, it doesn’t. It’s a risk.
Before you start investing, it is very important that you learn about the different types of investments, and what those investments can do for you. Understand the risks involved, and pay attention to past trends as well. History does indeed repeat itself, and investors know this first hand!
Different Types of Bonds
Investing in bonds is very safe, and the returns are usually very good. There are four basic types of bonds available and they are sold through the Government, through corporations, state and local governments, and foreign governments.
The greatest thing about bonds is that you will get your initial investment back. This makes bonds the perfect investment vehicle for those who are new to investing, or for those who have a low risk tolerance.
The United States Government sells Treasury Bonds through the Treasury Department. You can purchase Treasury Bonds with maturity dates ranging from three months to thirty years.
Treasury bonds include Treasury Notes (T-Notes), Treasury Bills (T-Bills), and Treasury Bonds. All Treasury bonds are backed by the United States Government, and tax is only charged on the interest that the bonds earn.
Corporate bonds are sold through public securities markets. A corporate bond is essentially a company selling its debt. Corporate bonds usually have high interest rates, but they are a bit risky. If the company goes belly-up, the bond is worthless.
State and local Governments also sell bonds. Unlike bonds issued by the federal government, these bonds usually have higher interest rates. This is because State and Local Governments can indeed go bankrupt – unlike the federal government.
State and Local Government bonds are free from income taxes – even on the interest. State and local taxes may also be waived. Tax-free Municipal Bonds are common State and Local Government Bonds.
Purchasing foreign bonds is actually very difficult, and is often done as part of a mutual fund. It is often very risky to invest in foreign countries. The safest type of bond to buy is one that is issued by the US Government.
The interest may be a bit lower, but again, there is little or no risk involved. For best results, when a bond reaches maturity, reinvest it into another bond.
Different Types of Stock
The different types of stock are what confuse most first time investors. That confusion causes people to turn away from the stock market altogether, or to make unwise investments. If you are going to play the stock market, you must know what types of stock are available and what it all means!
Common Stock is a term that you will hear quite often. Anyone can purchase common stock, regardless of age, income, age, or financial standing. Common stock is essentially part ownership in the business you are investing in. As the company grows and earns money, the value of your stock rises. On the other hand, if the company does poorly or goes bankrupt, the value of your stock falls. Common stock holders do not participate in the day to day operations of a business, but they do have the power to elect the board of directors.
Along with common stock, there are also different classes of stock. The different classes of stock in one company are often called Class A and Class B. The first class, class A, essentially gives the stock owner more votes per share of stock than the owners of class B stock. The ability to create different classes of stock in a corporation has existed since 1987. Many investors avoid stock that has more than one class, and stocks that have more than one class are not called common stock.
The most upscale type of stock is of course Preferred Stock. Preferred stock isn’t exactly a stock. It is a mix of a stock and a bond. The owner’s of preferred stock can lay claim to the assets of the company in the case of bankruptcy, and preferred stock holders get the proceeds of the profits from a company before the common stock owners. If you think that you may prefer this preferred stock, be aware that the company typically has the right to buy the stock back from the stock owner and stop paying dividends.
When you start organizing your portfolio you will want to consider how you will be spending your money after you retire. Some money will be deposited directly into your checking account; such as Social Security where as other income could be less predictable. It is always nice to get extra income you are not counting on but you must not plan on this.
Some investments pay on a regular basis such as bonds and annuities. The trick of the matter is to produce enough money year after year to sustain you for as long as you will need it. In order for this to be accomplished your profit must be greater than the rate of inflation. In other words it is necessary that some investments grow in value at the same time that other investments are providing you with income.
Some reliable companies that pay dividends can provide a steady income if they are continually growing themselves. Because this is unpredictable, however, it is important then to have some investments that are reliable and are in an instrument that can be depleted. You will want to organize the amount of withdrawal from different instruments so that your assets will last as long as you do. It would be wise to take from the amount that you receive monthly and put a reserve away for large but anticipated expenses.
It is all right to deliberately spend your money as long as you don’t die before it runs out. Tax deferred investments make it mandatory for withdrawals to be made. IRAs are a good example of this. Withdrawals from annuities work the same way. Taxable investments work differently. You can choose how much you might care to withdraw and you can allow the principal to keep growing. By having the options with different retirement accounts you broaden your base and organize a portfolio that should cover all areas at retirement.