The stock market can take on many different roles for different people. For some, it is a way to raise funds and others, a reason for employment. For the majority, however, it is a means to prepare for the future, whether near or far. Of the many facets of the stock market are stocks, mutual funds, and bonds. These three make up the most common forms of investments that one may utilize. Each has its own pros and cons but deciding which one to use is really up to what you wish to accomplish with your investment.
Common Stock
Common stock is the most recognizable means of investment and will most likely be what the average person thinks of when they hear the word ‘investment’. A share of stock in simple terms is a representation of ownership in a firm. Publicly traded firms sell shares of stock on the stock market to raise funds for business expenses. Once shares have been sold, the performance of the firm dictates the value of shares in that company. Out of the three forms of investment we will be discussing, stocks are by far the most volatile and, consequently, the most risky. Due to this inherent risk associated with stocks, they are also the investment with the largest returns.
When it comes to investing, the allocation of funds is crucial to your success in the long run. The outdated rule of thumb was to subtract your age from 100 and that number is the percentage of stocks you should own as opposed to bonds and mutual funds. For example, take a 25 year old. Their investment allocation should be 75% stocks and 25% bonds. The idea behind this allocation rule is that as you get older your risk tolerance decreases.
This adage has become obsolete however, as the trend has gone two complete different directions. Many investors hold very low percentages of stocks still fearing a repeat of the financial crisis of 2008. Contrarily, institutional investors are creating portfolios that rely heavily on high allocations of stocks to yield much higher returns. These investors, however, have large fund cushions to fall back on whereas the average young investor does not. (Marsh, C)
When discussing the advantages and disadvantages of stocks, the lines are actually very blurred because many of the advantages can actually be disadvantages. For instance, the volatility of stocks makes them extremely difficult to grasp and predict meaning that the risk involved with buying is much higher as discussed earlier. So, in this case, the risk is both an advantage and disadvantage as it will result in much higher returns or larger losses. Young investors just have to remember the key point of stocks. Buy low, sell high. Today, many people have lost sight of that adage and simply buy stocks when they are doing especially well. This may seem as if the stock has infinite room to grow, but in reality it just has infinite room to fall. Remembering to buy low and sell high to mitigate risks. Now is a better time than ever to begin investing because, as the market slowly creeps back up after the recent recession, the general health of stocks will too. Especially when they are currently trading very low. (Rose, J)
Finally, the ease of investment in stocks is huge. With countless apps, websites, and brokers, it is almost impossible to not be able to find the right investment source for you. One pitfall, however, is many of these sources will take a percentage of your earnings and can even make it hard to get out once you’ve began. Doing research prior to using an investment source is crucial and finding the right one can save a lot of hassle. Take a look at the app store and Google before you decide. Nowadays, many apps offer "commission free trading" which is exactly what you're looking for if you plan to invest on your own. This allows your earnings to stay your earnings.
Here are a few apps to consider:
- Robinhood
- Webull
- E*Trade
- Charles Schwab
- Acorns
I personally use Robinhood and I highly recommend it. The platform is extremely user friendly while still providing all the tools you may need to successfully invest yourself. There are countless more apps that you can try, I have just provided a few. Just be sure to research each thoroughly before deciding on one.
Mutual Funds
As discussed earlier, allocating funds into less risky ventures is a must when building a portfolio. One that many investors turn to are mutual funds. A mutual fund is a company that pools money from multiple different investors and invests it in diversified portfolios containing stocks, bonds, and short term debt. Investing in a mutual fund is similar to investing in a stock. You buy shares of the fund that represent part ownership of the fund and all the income it generates. Mutual funds act as a means of diversification for many investors and even a simpler, more hands off approach to investing. If a more passive role is what you’re looking for, this is the direction for you.
When investing, the fund managers do all of the research and planning for the portfolio as well as monitoring the funds to ensure the success of the investments. As an investor, you do not have to worry about diversifying because the portfolio created has been created with a specific level of risk allocation in mind. In addition, they are fairly cheap to invest in and your funds can be easily withdrawn whenever you want. These funds also pay frequent dividends and pays its investors capital gains on sold securities. (US Securities and Exchange Commission)
All of these benefits do come at a price, however. One of the largest disadvantages of mutual funds is the fees. Due to the hands off approach of investors, there are fees that you must pay to the fund in order to invest, stay invested, and withdraw from the fund. These fees are mainly to cover operating costs and pay those that create the portfolios and actually do the investing with the pooled money. As opposed to stocks, these funds are not usually traded on the stock market and can sometimes be hard to find. The complexities of mutual funds can also make it difficult to monitor your own investments. That is why, in many cases, it is important for investors, especially young investors, to seek advice from a mutual fund adviser before investing. (The Economic Times)
As with all businesses, the legitimacy of mutual funds is a big consideration when looking for the right one to invest in. Some funds may hit investors with crazy fees to the point where the yield is outweighed by the amount being charged in fees to the fund. To avoid these mutual funds, be sure to research and read the funds prospectus that it is required to submit to the SEC before investing. Another way to evaluate the legitimacy of a mutual fund is to research the funds investment adviser via the SEC database. If the investment adviser is not registered with the SEC then the fund may be a scam. The goal of the investor is really what determines if a mutual fund is worth it because the hands off approach, low risk, and associated fees. All this may be attractive to one investor but not worth it for another. As a means of balancing your own portfolio with a less risky investment, it is a great deal because most of the work is done by the fund, however, relying solely on mutual funds will not yield very large returns as much of your earnings will be taken as fees. The advantages and disadvantages are better evaluated by the individual seeking to invest because it depends on their individual goals.
Bonds
In general, bonds are one of the lowest risk investments because of the almost guaranteed return. Of course, they are not foolproof as losses are possible in times of over inflated interest rates. For such a low risk investment, however, the returns far surpass money market funds and are even comparable to equities. (Stanton, E)
Since 1926, stocks have returned on average about 10% per year whereas government bonds return about 6% or 7% per year. As for money market funds, they only return just below 4% per year. (CNN Money) Considering the much lower risk tolerance needed to invest in bonds, they offer a great opportunity for wealth growth, especially as a means to balance out your portfolio. Bonds provide stability and competitive returns.
In theory, adding bonds to a portfolio that is populated only by stocks will lower the portfolios return, however, it will lower the volatility a much greater amount. Bonds are mainly the investment instrument of the retired as they provide a steady stream of income without the need of a cushion in case your investments plummet. Although good for older investors, they also provide much needed stability to even a young portfolio as it is a much more efficient use of risk.
As with mutual funds, it is important to make sure you buy your bonds at a good price. One of the pitfalls of bonds is the undisclosed markup on the bonds original price. Another issue that comes with bonds is the interest taxation. Municipalities issued by the federal and state governments are tax free, however, other US bonds are not. These bonds can cut into profits and even cause losses in your portfolio. So, once again, researching before you buy is critical to the success of your portfolio. Bonds are also often traded by mutual funds which can cause problems because the lower return can mean that fund fees will kill your own returns. (Stanton, E)
Bonds provide much needed stability in your portfolio and often substitute stocks for older and retired investors as a form of steady income and savings, however, as a young investor they should be used more as a risk reducer in your portfolio. The advantages of bonds being their stability contributes to their pitfall in that they provide lower returns. Bonds are a great option still for a young investor as a means of steady saving for the future.
Conclusion
All three investment tools discussed provided different benefits to the investor and varied risks and pitfalls. All, however, fit together to create a balanced, diversified portfolio. It is common practice to diversify your portfolio, however, for a young investor with little cushioning, it is detrimental to “put all your eggs in one basket”. The idea of diversifying does not necessarily mean avoiding losses, but it can make losses less destructive as their are still funds to fall back on.
In a portfolio as a young investor, stocks should be your cornerstone. As discussed earlier, their high return rates provide a good point to grow off of. (Carlozo, L) The gains will help beat rising inflation rates and, if done well, provide fast growing savings in the long run.
Mutual funds will be your safer bet when going into the stock market. Being a little bit more hands off but a little more expensive, they will provide similar growth minus their fees. As a main source of growth they are not as effective as stocks but can help in balancing your portfolio.
Bonds are by far the least risky. The almost guaranteed return that is competitive with many stock returns makes it the perfect candidate for diversification. The low risk will allow for a focus on stocks while not putting your funds in jeopardy of huge losses relying solely on high risk stocks.
In conclusion, not one form of investment is all around better than the others. Each has its own pros and cons and the use of each is up to the individual investor. In general, however, a mix of all three allocated to your specific risk tolerance is a good place to start as a young investor. Utilizing the benefits of all three is key to maintaining a safe, profitable, and successful portfolio.
Thank you so much for reading, I appreciate it. Any other topics you would like me to discuss, leave them below in the comments. Be sure to check back as I should be posting every week, if not more. Make sure to:
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Works Cited
Stanton, E. (28, January 1999) When to Buy Bonds - An Introduction on Why to Invest in Bonds. The Street. Retrieved from
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Investing in the stock market offers diverse opportunities and roles, catering to different goals and risk tolerances. Common stocks represent ownership in a company, offering potential high returns but with volatility and risk. While traditional allocation rules may no longer apply, understanding risk is paramount. Mutual funds provide diversification and management by professionals but come with fees and complexities. Bonds offer stability and predictable returns, making them ideal for risk-averse investors. Balancing these options creates a resilient portfolio, essential for weathering market uncertainties and achieving long-term financial goals.
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