The Ins and Outs of Investing
Episode #8 of the course Personal financial literacy: Take control of your future by Riley Burger
Welcome back!
Investing is a great addition to your financial toolkit. Today we’re breaking down the different asset classes, and financial instruments within each of them, so you can make educated decisions on how to diversify and curate your portfolio for your needs.
Equities: Shares of stock, representing proportional ownership of a company.
Financial instruments:
• Stocks. Ownership shares of a company, issued by publicly-traded companies. Stocks generally have more risk than fixed income, but usually produce higher returns.
There are two types of stock: preferred, and common. In the event of the issuing company’s liquidation, preferred stockholders get repaid before common stockholders but after bondholders. Preferred stockholders often do not have voting rights in the company.
Many stocks offer dividends, the distribution of a portion of the company’s earnings to shareholders on a regular or one-time basis. Dividends for common stock are generally variable, meaning a company can choose to raise/lower/end payouts at any time.
Fixed income: A type of security that pays investors fixed interest payments until a maturity date when the principal amount is repaid.
Financial instruments:
• Government bonds. Issued by local, state, and federal governments to finance government expenses. Generally considered some of the safest assets (low-risk). The terminology you may have heard: treasury bonds, treasury bills, municipal bonds, munis.
• Corporate bonds. Issued by companies to finance investments, research, and development, etc. Generally considered lower-risk assets. If the issuing company goes bankrupt and liquidates, corporate bondholders are paid back before shareholders.
Alternative investments: Assets besides equities and fixed income. With a very low correlation to equity and fixed income returns, alternative investments are great for diversifying your portfolio.
Financial instruments:
• Real assets. Tangible and intangible non-financial assets. This includes, among other things, real estate and land ownership, physical commodities like cars, art, and valuable jewelry, and intellectual property. Depending on the type, real assets can appreciate or depreciate in value.
For example, cars are not generally considered a good “investment,” as they “can lose more than 10 percent of their value during the first month after you drive off the lot,” and continue to depreciate in value with use (CarFax). In comparison, art can be an example of an appreciating asset; the value of a piece of art from a famous artist can increase over time.
• Real estate. Investing in real estate can take many forms. For high net worth individuals, this can look like investing in individual properties or REITs (Real Estate Investment Trusts). For many people, real estate investing is best through real estate ETFs.
• Commodities. Investment in natural resources, such as oil and gas, precious metals, and energy. The value of commodities works like equities, rising and falling with demand and supply. Commodities can help mitigate inflation risk in your portfolio. You can invest in commodities with instruments like index funds and commodity funds.
• Other types of alternative investments include hedge funds, private equity, direct investments in start-ups and private companies, and venture capital.
Pooled-fund investing: sharing the wealth
Mutual funds are pools of many investors’ money that are invested in a large portfolio of assets. Each investor then receives a proportional amount of the fund’s returns. Mutual funds are actively managed, meaning a group of financial professionals create and monitor the fund, buying, or selling assets to improve performance.
Mutual funds can be found to suit any investor’s needs, with any mix of stocks, fixed income, and alternative investments. Funds can be found for any of your interests or financial goals, including:
• Stocks in individual industries.
Ex. A manufacturing or tech fund.
• Stocks in either emerging markets (countries with less mature capital markets, lower income per capita, and rapid growth) or developed markets (countries that have robust existing capital markets and are often home to more mature companies).
• Specific alternative investment classes.
Ex. REITs (Real Estate Income Trusts) or other real estate mutual funds invest money into a portfolio of properties and mortgages.
• Stocks and fixed income products for specific interest groups.
Ex. SRI (Socially Responsible Investing) and ESG (Environmental, Social, Governance) funds focus on one theme and build a portfolio around it. For example, an ESG fund for supporting gender diversity within the workplace would invest only in stocks and corporate bonds of companies that are leaders in this issue (companies with women on their board of directors, with recruiting programs for women, etc.)
Exchange-Traded Funds (ETFs) are securities that track an underlying index, representing many individual stocks or assets at once but traded like a stock. Most ETFs are passively managed, meaning they track a predefined segment of stocks or assets and are not fiddled with by investment professionals.
This leads ETFs to have lower management fees than mutual funds. ETFs can be found for almost every interest group listed in the mutual fund section, and can also be found for things like currencies and commodities.
For similar security in the fixed income space, look into Exchange Traded Notes (ETNs).
We sorted through some of the main financial assets, so now would be a great time to dive deeper into any of the assets that interest you the most!
Now that we’ve discussed asset classes and different kinds of investments, we’ll put this knowledge to work in our next lesson on setting up an investment portfolio.
Until tomorrow,
Riley
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