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One of the most frequent questions I hear is, "How do I start investing?"
To me there is a lot under that question that I need to massage out before I just recommend a fund or particular stock. Why do you want to invest? Short term or long term? How much can you invest? Do you have enough in liquid savings? And more…
Once we get past the fiduciary and/or suitability type of questions I start to see what most people really mean when they ask, "How do I invest?"
WTF does all this mean?
That’s what we're looking for. How do I understand what I'm doing so that I don't make a mistake that I regret. Side note: I love the meme of the tattoo that says, "No ragrets" LOL!
Check out this really interesting Google Trend I found! People are more and more interested in how to invest. So here we are, what does all this mean? I wanted to break down the few most common types of investments and how they work so you can become a little bit more investment savvy.
Equities are also known as stocks. Essentially they are pieces of the pie, for ownership of a company. When you hear people talk about investing for equity in a company, they will own a percentage of stocks that gives them right to profits of the company. They are the most popular investment instrument, and typically the most misunderstood!
When you buy a share of a company like Amazon or Facebook, you're typically purchasing that on the open secondary market. It's like trading baseball or Pokemon cards. It's all supply and demand based on what the buyers and sellers think the future value will do.
If you think a stock could rise more in price based on the performance of a company, you may want to buy. If you think a company isn't going to do so well and others will want to sell later, thus dropping the price. Then maybe you'll sell.
The stocks hit the public after an initial public offering (IPO) and then trade in perpetuity until the company buys back all the shares from the holders or the company folds and the shares are worthless.
So when Mark Zuckerberg or Jeff Bezos became rich it was because they owned the biggest slice of the pie, of a HUGE company that was continually growing in value.
That’s it. Pretty simple, huh? I'm being silly, but the US stock market runs on indexes that follow the largest 50-500-2,000 companies. When you hear on the news that the "market" went up or down they are typically looking at a larger view of a few big companies.
Someone like Warren Buffett became wealthy because he bought entire companies or majority shares of companies that he thought would do well. As the companies performed, their share value went up, and thus Buffett's net worth. Jeff Bezos is currently the richest man in the world because he owns about 16 percent of Amazon. 16 percent of the shares!
Bonds are essentially promissory notes to companies and governments. You allow the entity to use money at an agreed upon interest rate, with regular payments. Typically they are denominated in the thousands. So if you buy $10,000 worth of bonds at three percent you will give $10,000 to the entity and receive $300 per year in interest for the life of the bonds until they come due and you receive the $10,000 back.
They are normally "safer" than stocks because they have a credit rating and large company or government backing them with guarantee of payment.
They do trade on a secondary market though. Imagine that you get bonds at three percent and new ones come out at six percent! You would want that one, and so would other people. So you'd sell your $10,000 of bonds at a discount, let's say $9,500 in order to entice someone to get the three percent and the $10,000 back in the future.
The opposite is true, if interest rates fall the one percent someone would have to pay you quite a bit more that $10,000 to get those bonds from you.
There are a lot of equations that go into it, but for basics we can stick to that.
3. Mutual Funds
Mutual funds are actually investment companies that go and buy millions if not billions of dollars worth of stocks and bonds and then trade their own shares for the respective performance of the underlying assets.
The mutual funds typically compete against each other on management costs, investment performance, and even the types of investments (US stocks vs. international or real estate vs. bonds, etc.).
Mutual funds are like a shopping cart of equities and investments. The fund manager goes around picking what they deem as the best "cart" of groceries (investments) and then you get to vote with your dollars to decide which cart to pick.
Typically with most retirement accounts they invest via age-based mutual funds. If you're 30 years old today you may see a Vanguard 2055 fund in your 401k. That fund will have a more aggressive take on investing today (more stocks) and then chill out over time taking less risk (more bonds) as you get closer to 2055.
There are tons of other investments with commodities, real estate, ETFS, derivatives, hedge funds and loans. I wanted to a least provide a starting point for what most people mean when they think about "how to invest" and where to start!
I"m here for you, I don't want to you have any regrets.