The Big 6: Mainstream Investing Types
When I talk about “The Big 6,” I’m referring to the mainstream investments that you commonly see in media—hence the specific use of the word, “mainstream.” In any investment, the idea is to have long term growth and investments that adhere to your specific risk tolerance. With “The Big 6,” we mostly exploring the most common investments that people get into over the course of their income producing lives.
The word “investment(s)” can often time be misconstrued because often times, the mainstream media will refer to investing as having money in the market-- I assure you, there are many more ways to “invest.” However, for the sake of discussion, let’s look at what the mainstream media describes as investment types for the everyday investor.
“The Big 6” consists of the following areas of investing:
- Mutual funds
- Index funds
- Exchange-traded funds (ETFs)
Contrary to what I generally write about, this won’t be a “this is good, or this is bad” type of discussion. This will be much more informative of the different forms of the Big 6 and what they do individually. I would also point out that each of these do have different tax implications, which should certainly always be considered when investing as a whole—that would require a very in-depth analysis to determine which way you want to go. Nonetheless, let’s look at the mainstream Big 6 and you can go on your merry way!
Stocks as an investment is just believing a company will grow and putting your money in that company, expecting a return. Simply put, when you buy a stock, you’re buying a “share” or a small bite-sized piece of a company’s earnings and assets. Investors can then buy and sell shares among themselves, all while companies sell shares of stock within their business to raise capital. Buyer-beware though, companies can often run into cash flow issues or even management—just to name a few—that can derail the company and thus, you can lose your invested capital.
Investors can make money on stocks a number of different ways, but the main way—the mainstream way—is when the value of said stock goes up, you eventually sell that stock for a profit. Investors can also make money on stocks through dividends or shorting a stock as well.
Simply put, a bond is a loan you make to a company or government(s). A bond is a lot like being a part of a massive coupling where capital is lent out to said companies or governments to operate in the form of a line of credit. There’s a decent pool of bonds that you can consider, but in general, the less risky the bond, the lower the interest rate you’ll get on the bond.
The way bond investors make money is usually twice a year, interest is generally paid back to investors. Bonds are fixed-income investments thus its investors are expected to be paid regularly until the principal of the bond hits it’s maturity date.
For most people, mutual funds are attractive because there are quite literally a collection of stocks and bonds as well as other assets. In short, mutual funds allow investors to purchase a large group of stocks, bonds, and other assets through a single transaction. In most cases, the fund is run by a professional money manager that then uses your money to purchase what they believe to be a winning bundle.
Mutual funds generally have their own strategies based on their data and expertise in specific areas of the market and invest accordingly for the investor. Vetting a particular fund tends to be the best way to make an educated decision on which fund to be invested in simply by looking at their investment history and risk tolerance.
Mutual funds tend to be a more direct-to-consumer strategy of investing rather than tracking a specific market index. For reference, Invesco is a mutual fund.
Investors make money on mutual funds through stock dividends and/or bond interest. Simply put, when the investments within the fund go up in value, the value of the overall fund goes up and thus, your ability to profit off the sale of your fund increases as well. It should be noted that mutual funds do have an expense ratio fee that is due annually to invest in a mutual fund.
An index fund isn’t much different than a mutual fund, but rather instead of the manager hand picking the stocks, bonds, and other assets to invest in, index funds track market indices. If you’re unfamiliar what a market index is, think S&P 500, Dow Jones, Nasdaq, Russell 2k, etc.
The nice part about index funds is that there’s generally low fees associated with them because it’s not as hands on as a mutual fund. However, there’s certainly risk in index funds because the companies that the fund are invested in may not be up to snuff and thus, you can lose your investment. In general, index funds tend to be a safe, conservative play for the most part.
Investors in index funds make money on the dividends or interest of the earnings of where they are invested. Of course, investors can always sell their position within the fund and earn a profit, but like mutual funds do have an annual expense ratio. However, it should be noted that because this is a more hands off approach than mutual funds, the annual expense ratio will be lower than that of a traditional mutual fund.
Much like index funds, exchange-traded funds-- ETFs for short—attempt to mirror market index’s performance. In most cases, ETFs are also a cheaper alternative to mutual funds as it pertains to fees because they aren’t as hands on, or if you’re looking for a fancy financial term: they aren’t “actively managed.”
ETFs are different from index funds or mutual funds because they can be bought and sold multiple times a day, whereas index funds and mutual funds can only be bought and sold at the end of each trading day. ETF prices fluctuate throughout a trading day as well, so it goes without saying that many investors who favor ETFs will have a higher likelihood of being more active than passive. This isn’t always the case, though. Many owners of ETFs favor ETFs because there’s simply more flexibility on the price of the fund.
Investors make money on ETFs in a similar fashion as mutual funds or index funds. By increasing the value of said fund, you can sell your position and make a profit. However, ETFs can also pay out dividends and interest with good performance.
Options are essentially a contract to buy or sell a stock at a specific price, by a specific date. That contract doesn’t obligate you to buy or sell the stock though, hence the name “options.” Contracts generally consist of 100(ish) shares of a stock.
It should be noted that when you buy an option, you’re buying a contract, not the stock itself—sort of like wholesaling in real estate.
Options tend to be a confusing investment category which is why many people either: A. say options don’t work—mostly because they don’t understand how they work, or B. don’t even know they really exist as an investment opportunity. Without getting too far into the weeds, you are attempting to lock in option prices at a low so when you sell the bundle, you make money. If you’re right, you initially purchased the option at a low price and sold them at the higher rate later. If you’re wrong, you're only out the cost of the initial contract price.
I want to remind people that this isn’t the only way to invest your money. Of course, it’s important to be “diversified”—I hate that word so much—but in reality, there is certainly people making money in the market(s) and within the Big 6 of mainstream investing. However you chop it up, understand that there are definitely options—pun intended—for you to invest your money in. I want to remind people though that there is always risk in market investments and when you put your hard-earned dollars toward something, it should offer a favorable return for you. Most importantly, understanding and calculating the risks involved is of the utmost priority to you and your money.
For more information go to www.lyvfin.com and schedule a meeting with a trained professional to calculate your risk exposure and estimated future values.