SUMMARY: Three of the most popular types of investments are stocks, bonds and mutual funds. Read this post to learn the differences and advantages of each.
Of the many investment options out there, by far the most popular are stocks, bonds and mutual funds. There are a number of factors at play when you’re deciding how much of each to incorporate into your portfolio.
The first consideration is risk. How strong is your stomach for when the market takes a dip? Are you cool under pressure, or do you need the Pepto within arm’s reach?
Next is time. How much of it do you have to spare for reading up on each individual company and getting your financial literacy up to speed?
Finally, consider fees and expenses—each investment vehicle comes with its own set and its own tax implications.
Below, we lay out the unique traits of each option and provide food for thought on how to turn them into a viable, diversified portfolio.
A stock is a small ownership share of a company, and each individual purchase helps fund that company’s operations and priorities. Your rate of return will likely be higher than with bonds, but so will your risk.
This is where growth can happen, going from baby steps to giant leaps toward your eventual financial goals. When you invest in order to achieve a long-term dream, such as a comfortable retirement, inflation can become an issue, but stocks are typically well-positioned to match or exceed it.
Stocks can provide income in two ways:
Dividends: These provide reliable, taxable income with quarterly or annual payments.
Money from the sale of shares on the open market: Since stocks trade throughout the day, the price will vary.
Fees are par for the course but vary widely depending on the level of service you require. The more professional advice you need—up to and including a full-service broker—the more fees you will encounter.
A bond is a contractual obligation you enter into with a company or government body. You agree to lend it your money to fund various operations and services, and it agrees to pay you back with interest over a period of time.
Savvy buyers will look for these three characteristics in a bond:
Income: Generally, bonds will pay interest semiannually, with the principal returned in full when the bond reaches maturity. Bonds are not known for high, fast income growth but can reward the patient investor over time.
Diversification: Bonds tend to move in different directions than stocks, meaning that a downturn in one likely doesn’t mean another will follow suit, except in rare instances.
Safety: Even in the worst of times, bond market downturns tend to be far less severe than with stocks. A 3 percent drop represents a run-of-the-mill off day for stocks but a huge loss for bonds, meaning that changes of this magnitude are few and far between.
When used strategically, bonds of short to intermediate maturity (10 years and under) can provide safe, reliable income over the long term.
If the idea of researching, selecting, and monitoring every stock or bond in your portfolio gives you nausea, you would be wise to consider mutual funds, which purchase a variety of stocks or bonds, group them into funds, and sell shares, each of which is worth a certain net asset value.
This strategy can significantly lower your risk. If one company in the fund has an off day, week, or year, odds are that others in your portfolio are either booming or at least holding their own—the best qualities of stocks, without some of the volatility.
One downside is that you give up a certain amount of control—someone else decides which investments to make, how to manage them, when to get out, and so on. That said, most of us aren’t Gordon Gekko and would be easily overwhelmed by the sheer number of options and pitfalls out there. And because mutual funds contain both stocks and bonds, they likely won’t perform at the same peak level as stocks.
While you may give up some control, mutual funds are a great way to ensure a robust, diverse portfolio that comes at a relatively low cost.
The right mix? That’s up to you
There’s room in your portfolio for all three of these investment options, but much like with the spread at your family’s Thanksgiving dinner, portion size is up to you. TDECU’s Complete Road Map to Retirement e-book is an excellent primer to get you started on this journey.