by Andrew Horowitz
In this episode, I'll review for you the major types of investments or major markets and from those you will continue to build your portfolio to make the best 2010 possible!
What Are the Main Ways to Invest?
When most people think of investing, they think simply of stocks and bonds. They also hear about how important it is to have a diversified portfolio.
To review, a diversified portfolio contains a carefully planned balance of different types of stocks, bonds, and well as mutual funds along with commodity and currency exchange-traded funds for those so bold to own them.
How to Have a Diversified Portfolio
To have a carefully diversified portfolio, you may need to consider adding currency and commodity exchange-traded funds to your portfolio.These investment vehicles take your portfolio beyond the stock, bond, and mutual fund portfolios of most investors.
Before we get into the more exotic side of building your portfolio, let's step back and refresh bonds and stocks.
Bonds
Bonds are the safest of the four major asset classes, or major markets, because you are virtually guaranteed to get back what you invested with interest.
Bonds provide stability, predictability, and a constant income to investors. They are less volatile than stocks, which means their prices do not change as much. But in exchange for the stability and safety of bonds, investors typically get smaller returns or profits.
Think of a bond like a loan. If you buy US Government Treasury Bonds, then you are loaning the government money for a set period of time--usually 1 year, 5 years, 10 years, or 30 years--in exchange for a small interest payment, which is usually around 5% per year. You get a higher interest rate when you buy longer term bonds, such as the 30-year bond, but that means your money is tied up for 30 years.
Many winning investors are turning to bond exchange-traded funds, but ETFs carry slightly more risk than buying a bond from the government.
Speaking of risk, no risk, no reward, right?!
Stocks
Stocks are riskier than bonds, but over the long term, stocks generally outperform bonds, though there have been some scary years that stock market investors have been through--2008 was one of the worst!
If we think of bonds like a loan, we think of stocks as ownership. When you buy a share of a stock, you buy a small piece of ownership in a company. If you do your research and buy shares of a strong company that grows and grows each year, then it can be a very rewarding endeavor.
So now, a lot of people are scared of the stock market because they lost a lot of their nest egg or value of their portfolio in 2008. However, despite very bumpy years and the possibility of losing value, stocks have given wealth over the years to those who own safe stocks for the long haul.
Dividends-Paying Stocks
Many stocks pay dividends, which help provide income just like bonds. Dividends are like little "thank yous" that companies gives investors as a reward for owning part of the company; they are a way to share some of the profits with share owners. Share holders, as owners, get to vote on certain decisions that the company makes.
So even though the price of a stock might go up and down, the dividend payments are a stable source of income for stock investors. Just remember that not all stocks pay dividends.
Mutual Funds
Because picking stocks and building your own portfolio can be difficult, a lot of investors trust money managers of what we call mutual funds.
A mutual fund is a group of stocks that are selected by a money manager or group of money managers at a financial company where the goal is to beat or outperform the stock market. The money managers put together a diversified portfolio of strong stocks that they think will outperform the broad market, and thus give you better returns or profits than if you had just invested in an exchange-traded fund like the SPY for the S&P 500 or DIA for the Dow Jones Index.
There are many, many types of mutual funds--there are literally thousands of funds to choose from. Online websites like Yahoo and Google Finance can help you select a mutual fund. You can also speak with your local financial adviser.
You pay a small fee--usually less than 2%--to own a mutual fund because the company or money managers deserve compensation for their knowledge and work on your behalf.
However, some people prefer just to own stocks, or an index like the S&P 500 or the Dow Jones and they aren't concerned with beating the market. Also, not all mutual funds beat the market-- some actually underperform; they earn you less than if you had purchased an exchange-traded fund. Fewer mutual funds outperform the market when you add in the cost of the management fee, which means the funds would have to beat the market by 1.5% or 2% to make up for the fees associated with them.
Exchange-Traded Funds
That's why a lot of investors are turning to exchange-traded funds. Unlike a mutual fund which you can buy or sell only at the end of the day (and usually you have to buy them through a broker), an ETF behaves just like a stock, and you can buy it or sell it any time during the day.
If you want to own stocks in general, you might decide to purchase shares of index ETFs, which trade under the following symbols: SPY for the S&P 500 (all 500 stocks in the index), DIA for the Dow Jones Index (all 30 stocks), and QQQQ for the 100 stocks in the NASDAQ 100 Index.
You won't outperform the market, but you'll get almost exactly what the market returns for that year. That might not sound good at first--we all want to beat the market--but if we want to build a diversified portfolio, buying EFTs might be a good choice to make ETFs are becoming a more popular solution to investors because there's no management fee—though you do have to pay a very small fee, usually half of 1 percent, to the company who produces and maintains the ETF. That's still less than a mutual fund.
More on ETFs
Did you know that there are more than 600 ETFs?! There's almost an ETF for anything you can imagine. There's even an ETF for water! There’s one for agriculture that trades under the symbol MOO just like a cow. There are a few ETFs for gold, including GLD, and ETFs for silver--SLV and many, many more.
You can actually build a full diversified portfolio just on ETFs alone! There are different types of bond ETFs, commodity ETFs, currency ETFs, and stock market sector ETFs like the financial sector (symbol XLF), health care sector (symbol XLV), and many many more.
Leveraged ETFs
There are even leveraged ETFs, which are ETFs that juice your returns by a factor of two or three times what the standard ETF would return. Examples include FAZ for the double long leveraged financial sector ETF. As you might guess, these are riskier than standard ETFs.
If you are afraid of short selling a stock, which means you profit or make money when the value of the stock falls, then there are even what we call "inverse" ETFs that are just like shorting a stock.
If you want to add currency exposure, like adding the euro to your portfolio, you can use the ETF symbol FXE, or you can add the US dollar to your portfolio under symbol UUP.
There's way too much to talk about in one episode! Review our prior podcast on different types of ETFs.
Summary
So you have bonds, stocks, mutual funds, and ETFs. Those are the four types of major markets, though most people just stick with what they know which is stocks and bonds and that's fine too.
Just know that there is a whole world of possibilities for you to choose from and ETFs can help you create a balanced and winning portfolio--so let's get 2010 off to a great start!
Keep with us as we discuss even more ways to become a winning investor in our next podcast! If there’s a question you’d really like to ask, just email me at winninginvestor@quickanddirtytips.com .
Until next time, this is Andrew Horowitz with The Winning Investor’s Quick and Dirty Tips for making money in any Market, wishing you all the best on your quest to investment success.
