12 Jul 2017

A Beginner’s Guide to Investment Vehicles

A Beginner’s Guide to Investment Vehicles

Of all the questions in the personal finance world, "What should I invest in?" easily comes to mind as the most common. Truth be told, there's really not a 100% correct answer or blueprint for people that are just starting out in their careers.

However, if you arm yourself with as much information as possible, it's so much easier to jump in and create your own investment strategy.

Even before we jump into potential strategies and goals, it's important to have a baseline understanding of what's out there to actually invest in! In this two-part investing series, we are going to take a look at the most common investment vehicles that will be available to a beginner investor.

For the purposes of this article, we are going to avoid real estate investments (for now). The following list will give a baseline definition of the investment vehicle, as well as important characteristics like what level of fees are typically involved and how much risk is associated.

Here are a few of the main investment vehicles that you need to know about early in your career:

1. Stocks

Diversification: Low

Risk: High to Moderate

Fees: Low

Stocks Definition: “Security that signifies ownership in a corporation and represents a claim on part of the corporation’s assets and earnings.”

What you need to know:

Almost everyone has heard of stocks (commonly called shares or equities) in some form or fashion. When you buy stock, you are essentially buying a small part of a specific company.

To purchase stock in a company, you have to use a broker like Schwab, E-Trade, Fidelity, etc., to manage the transaction. The broker will charge a fee per transaction that you make through their purchasing platform. Because there are so many brokerages available online, fees in recent years have become extremely low and can range anywhere from $4 to $7 per trade.

In terms of risk, stocks aren't all created equal. The quality of a company that you are buying is a major factor in how risky a stock can be. Blue chip stocks like Coca Cola, Exxon, and the other large companies that you can think of tend to be seen as less speculative, whereas smaller, unproven companies can be more risky to buy.

You do not need a fund manager to invest in stocks, unlike some of the other vehicles on this list.

2. ETFs

Diversification: High

Risk: High to Low

Fees: Low to Moderate

ETF Definition: “An exchange-traded fund is a ‘marketable’ security that tracks an index, a commodity, bonds or a basket of assets like an index fund.”

What you need to know:

ETFs have become extremely popular in recent years, because they combine a variety of investing options with a large amount of diversification while having low fees.

An ETF essentially tracks a sector like energy, or an entire market like the DOW or NASDAQ. So, if you were to buy an energy ETF, you would actually be buying shares of several companies that are contained in that particular sector.

The range of investment options with different ETFs allows investors to choose their particular level of risk.

3. Mutual Funds

Diversification: High

Risk: High to Low

Fees: Moderate

Mutual Funds Definition: “An investment vehicle that is made up of a pool of money collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets.”

What you need to know:

Mutual funds are an extremely popular investment vehicle because they specialize in diversification. Like an ETF, when you invest in a mutual fund you are actually buying a variety of stocks.

There are many different types of mutual funds, but for the purpose of this article we are going to focus on "actively managed" funds.

Actively managed means that there is a fund manager that oversees the investments made within a specific mutual fund. Their goal over time is to guide the fund in a way that hopefully outperforms the market.

This active management does lead to extra fees associated with the mutual fund, which will have an effect on your overall return on investment. In addition, mutual funds can have a higher tax burden than other diversified investment vehicles (like ETFs) because more transactions are made by the fund manager that are subject to capital gains tax.

There is a large range of investment options associated with mutual funds, and even mutual funds that invest in a range of other mutual funds!

4. Bond Funds

Diversification: Moderate

Risk: Moderate to Low

Fees: Moderate to Low

Bond Fund Definition: “A fund that invests in bonds or other debt securities.”

What you need to know:

A bond is a debt investment in which the investor loans money to a borrower, and then after a certain period of time is repaid with interest. Bonds are typically thought of as much more stable than stocks, but have lower returns on an investment.

Bond funds operate in a similar way to mutual funds, and are often actively managed by a fund manager. Rather than buying stocks, a bond fund will invest in a variety of bonds.

Interest rates can have a major effect on bonds and bond funds, so it's important to keep track of how the Fed is currently setting rates (at the time of this writing, the Fed is slowly raising interest rates).

5. Money Market Accounts

Diversification: Low

Risk: Low

Fees: Low

Money Market Account Definition: “An interest-bearing account that typically pays a higher interest rate than a savings account, and which provides the account holder with limited check-writing ability.”

What you need to know:

Money market accounts operate in a similar way to a regular savings account and are seen as one of the safest investment vehicles.

The investor places money in the account, and is given a return by the bank at a set rate over time. These accounts can be a good option for investors that may not be ready to jump in fully to investing, but don’t want inflation to diminish the value of their available cash.

Usually, banks will take money that is invested in a money market account and buy low-risk vehicles like certificates of deposit or debt securities with a short maturity rate. The idea is to create a return on investment without risking too much to market volatility.

This is just the beginning...

There are obviously many more investment vehicles out there (we didn't even mention real estate!), but the key to early investing is to keep everything as simple as possible. If you stick with understanding the basic options and grow your strategy from there, you'll have a long and successful stint with investing over the course of your career and life.

In part two of this series, we'll discuss how to define your investing goals and ultimately develop the right strategy to meet them.

-- Bobby Hoyt is a former high school teacher who paid off $40,000 of student loan debt in a year and a half. He now runs the personal finance site MillennialMoneyMan.com full-time, and has been seen on CNBC, Forbes, Business Insider, Reuters, Marketwatch, and many other major publications.

The opinions and advice expressed in this article are those of the author and do not necessarily reflect those held by the American Psychology Association (APA).

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