Equity – Exploring Investment Options

Understanding how to invest your greenbacks wisely begins with understanding where you can put your money. How can you begin to choose where to put your money until you know what’s out there? This article will briefly go into the common types of equity that exist, to help you decide where to invest.

What is Equity?

At Manage Your Means, we follow the Investopedia definition of Equity:

… equity [is] ownership in any asset after all debts associated with that asset are paid off. For example, a car or house with no outstanding debt is considered the owner’s equity because he or she can readily sell the item for cash. Stocks are equity because they represent ownership in a company.

So, anything you can put money in, own something, and sell it for money later is equity. That’s a lot of stuff! Of course, some types of equity are better than others. For example, buying a new car today is a terrible, no-good investment tool. It’ll lose around 60% of its value in just 5 years! We’re going to focus on equity that’s proven to usually grow over time, talk about how effective they are as a tool for investing, and what the associated risk is.

Stocks

Risk/Reward: Moderate to High

Knowledge Required: Moderate

The term Stock is commonly used interchangeably with Share. Stock is the money a company gets when they sell shares of their company. A Share is an equal portion of a company. When we talking about buying stocks, we’re really talking about buying shares, and therefore being invested in the stock of the company.

The stock market is a powerful investing tool. Many people make their living doing nothing but investing in the market. Historically, the stock market has the highest average rate of return of any investment vehicle!

If Imaginary Ivan puts $1,000 into MYM shares at $10 and the stock price rises to $20, Imaginary Ivan’s portfolio just increased to $2,000. However, the converse is also true. If MYM goes bankrupt, Ivan would lose all of his investment.

Understanding how to identify relatively stable stocks that are likely to provide gains from growth and dividends over time is what stock investing is all about. The glorious beauty of the stock market is that there are such a wide range of stocks to choose from, there is something for every investor. However, this means it can be difficult at times to see the trees through the forest. If you need help with ideas on how to select which stocks you should be investing in, check out our Weekly Wisdom segment – Stock Market Saturdays.

Mutual Funds

Risk/Reward: Low to Moderate

Knowledge Required: Minimal

Think of mutual funds this way:

Fictitious-Felicia and her closest 1,000 friends all put their retirement money into a pool. Let’s say they’re all just starting out, so they each put $1,000 in. The pool is at $1 million total. Felicia and her posse hire a fund manager to pick a bunch of good stocks and take care of your retirement money.

This is essentially what a mutual fund does. Why would Fictitious-Felicia do this? The answer is simple, really. First, being invested in a diverse set of stocks takes a lot of risk out of investing. If one stock does poorly, Felicia can be protected by the other stocks that might are doing well. Second, since she only has $1,000 to invest, she can’t invest in dozens or even hundreds of stocks. Even if she could, the fees would be way too big for managing those assets!

Mutual funds charge a small fee to take your money and lump it in with other people’s money so it can be invested evenly across the fund’s portfolio. This allows you to have a diverse portfolio without needing to have a large amount of capital, and allows for less fees overall compared to managing each of the assets yourself individually.

Most mutual funds have a niche or belong to a category. They might target value stocks, or growth stocks, be limited to small or large cap, etc. Take time to read about the mutual fund you plan to invest in to make sure it aligns with your personal investing views.

Bonds

Risk/Reward: Low to High

Knowledge Required: Moderate

Bonds are a debt investment. You agree to issue a bond to the government/company/municipality that is asking for the loan, which states the interest rate that will be repaid along with when the bond is to be repaid. The duration of the bond and the credit quality of the entity being issued the bond determine what the interest rate will be.

Bonds can vary in risk the same as stocks. Picking a bond with a high credit quality rating is much more secure than picking a lower rated ‘junk’ bond.

Currency/Forex

Risk/Reward: Extremely High

Knowledge Required: Extremely High

 I’ve decided I’m not to get into Forex trading too much in this article, except to describe what it is. Why? Because, Forex is incredibly difficult to invest in successfully. Less than 30% of people are profitable in it, and it is astoundingly risky. Using leverage, you can lose your entire life savings and more in a single trade. It’s a gamble, and not one that’s worth your time. You’re better off playing blackjack.

With that rant out of the way, Forex is the market currencies are traded in. It’s the most liquid market in existence, with over $1.9 trillion traded per day on average. You buy one currency, simultaneously sell another, and if the difference between the stock you bought and the sold increases, you earn money. Forex allows for leveraging up to 50 x 1, meaning if you put up $100 and the price difference went up $10, you’d make $10 x 50 = $500. The incredible risk involved is that going down $10 means you lose $500 and owe $400 on top of your $100 investment.

Again, don’t invest in Forex unless you’re a trained professional and it is your career. Please.

Commodities

Risk/Reward: Extremely High

Knowledge Required: Extremely High

Examples of commodities are gold, oil, corn, wheat, silver, coffee… lima beans? etc. Any good that can be purchased where the competitor’s product is virtually identical can be considered a commodity. When commodities are traded, they must also pass a basis grade to further ensure that one quality is the same as another.

With commodities, you’re agreeing to buy the good for a set price now, betting that the price will be better in the future, before the contract becomes due. Similar with Forex, Commodities can be leveraged significantly.

I’ll make the same plea again as I did with Forex – please avoid investing in commodities yourself unless you’re a trained professional. If you really want to add commodities to your portfolio, look at something like the Barclays CTA Index

Real Estate and REITs

Risk/Reward: Moderate to High

Knowledge Required: Moderate

Becoming a landlord can be a great investment. Houses generally increase their value over time, and generating income from a tenant’s rent can help you earn long-term gains. Landlording isn’t for everybody, though. The risks involved with being a landlord is that something disastrous could happen to your rental property, or you could face problems with your space becoming vacant for too long. Being able to do small repairs on your own will go a long way to keeping your maintenance costs down.

Another option for those who want to get into real estate in a less direct manner is Real Estate Investment Trusts (REITs). REITs act like a mutual fund would on the open market, except instead of investing in a bunch of companies, you’re investing in a group of real estate properties and mortgages. They typically provide high dividends, and can be a good way to diversify your portfolio.

For the average investor, I’d still advise to stay away from REITs. They are too risky to invest in without a moderate understanding of how to analyze the health and quality of a REIT.

Collectibles

Risk/Reward: Extremely High

Knowledge Required: Low to Moderate

What makes a collectible different from other equity options? The biggest difference is that damage to a collectible can decimate its value. For example, 2 pounds of gold dust is still worth as much as a 2 pound bar, but a shredded baseball card isn’t worth a dime. In general, collectibles should be considered a hobby and not a stable retirement avenue. Especially in this modern era, it can be difficult to predict which items will increase in value after several years.

Final Thoughts

With all of these different choices in equity available, where should you put your money? For most people, some combination of stocks, mutual funds and bonds will be more than enough to sate your investing hunter.

– Sam

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