Choosing the investments that are right for you is always a little bit of a guessing game. Of course, investing is inherently risky, and the unknown future is the main cause of that risk. But it’s certainly easier to decide how to diversify your portfolio and grow your retirement income when you understand the difference between the four most common investment types. Here’s our guide sharing basic definitions as well as some insight into these investments and the risks associated with each.
Definition of a Bond
A bond is issued to fund a special project by a company or at multiple levels of government. This could be research and development, building roads and schools, or even a war effort. Every person or entity that invests in a bond is essentially getting an “I.O.U” promising their investment will be paid back by a certain date, called the maturity date. You also receive a coupon for a certain interest rate that is a fixed rate of return on the bond.
At regular intervals until the bond matures, usually once every six months, you as the bondholder will receive a payment of the coupon rate of interest on your investment. When the bond maturity date arrives, your initial investment is paid back all at once.
Buying and Selling Investment Bonds
Another important notion that relates to bond investment is the concept of yield. This becomes relevant when you want to buy or sell a bond that has already been issued but hasn’t reached maturity. Yield is impacted by the difference between the coupon rate of the bond and the current coupons for new bonds in the market. This difference affects the price investors are willing to pay, and the profit the buyer will make on the bond. Bonds must be purchased through a broker, so talk with your broker more about this concept to find the right investment for you based on current and projected market conditions.
Bond Investment Risks
Generally, municipal and government bonds are considered an extremely safe investment. Some states even have laws that require governments to make bond payments before using their budget for any other purpose. It’s extremely rare for a city, state, or the Federal government to default on a bond.
Corporate bond issuers have a much higher risk of defaulting, but these investments also come with a significantly higher yield than a municipal or government bond. Always remember that all investment involves the risk of loss, even tried-and-tested options like a bond.
Definition of Stock
Each share of stock is a portion of ownership in a publicly traded company. It’s important to know that in most cases, this doesn’t guarantee you any input or managerial oversight in the company, unless that is a separate agreement you reach with the business, like in a startup or as an employee. Some stock does come with voting rights that allow shareholders to have some high-level control over the company’s direction. But generally buying stock is a vote of confidence in the company’s direction and future as it exists.
Buying and Selling Stock
Like bonds, stocks must be purchased through a broker. Full-service brokers are the financial experts we picture on the trading floor. They usually provide advice about finances and investment to their clients. Online brokers that offer less support bring a more modern approach and follow instructions to allow individuals direct access and control over their own investments.
Stock Investment Risks
The risks of stock investment are legendary, as are the returns. Overall, many professionals would agree one of the riskiest parts of investing in stocks is the role of emotions like greed or fear. Many individuals establish sell orders in their portfolios to automatically sell a stock when a certain rate of return is guaranteed. This takes some of the emotion out of the equation. As for the risks of losses, it’s important to consult with a financial professional about what percentage of your savings to invest in volatile options like stock, and how much to keep in options that are more stable. This will prevent fear from crippling you even at the lowest points of the market.
Definition of an Exchange-Traded Fund
Investors who are active in the stock market but looking for alternatives may consider an exchange traded fund (ETF). One share of an ETF represents a much smaller investment in the many stocks and bonds that are part of the fund. They work by tracking a specific index and aggregating some or all the bonds and stocks that are available in that index at any time. These could be relevant to industries like oil, or to certain nations and emerging markets.
Investing in an Exchange-Traded Fund
ETFs are traded through both traditional and online brokers, just like stocks. The price of each share of an ETF will go up and down throughout the day depending on the performance of the holdings in the fund. This option allows investors to distribute the risk of investing in a certain industry across many holdings, while also having the advantage of being able to trade directly with other investors based on real-time conditions in the market.
ETF Investment Risks
Just as the collective nature of the ETF brings benefits, it also brings some limits and risks. A lack of liquidity means you can’t only choose some of the investments in the fund to be part of. This is important to consider when choosing funds that are industry or region-specific—are you comfortable with the full scope of risk in the fund, and how the risk might change in the future? Depending on the way the fund is managed, these options may also come with high fees. Talk with your broker to get a clear picture of the fees you may be charged and why.
Definition of a Mutual Fund
Like an ETF, a mutual fund pools money from many investors to purchase stocks, bonds, and other investments. Investing in a share of the mutual fund represents a partial investment in all these holdings. However, a mutual fund is not publicly traded on the market. A mutual fund is also a company, led by a fund manager who is elected by a board of directors to make the best investment decisions for everyone involved in the fund. This is very different from an ETF, which functions by passively aggregating investments in a certain index without as much consideration of their potential performance.
Investing in a Mutual Fund
In 2018, 80% of mutual fund investors were investing through a retirement plan like 401(k) or IRA. In part, this is because participating in a mutual fund requires a minimum investment threshold of $1,000 or more, not just the cost of one share. It’s also important to know that trying to sell your retirement account shares in a mutual fund before age 59 ½ may come with penalties. Talk with your plan administrator or financial adviser to learn more.
Individuals can also buy shares of a mutual fund outside a retirement account, but your transaction will be with a broker who owns shares or with the fund itself. The same is true when you redeem your shares in the fund—you will only be transacting with the fund itself or a broker who represents the fund, not trading directly with other investors. Mutual funds are only traded once per day, after the stock market closes at 4pm ET.
Mutual Fund Investment Risks
One of the biggest risks of this investment type is fees. From transaction fees to administrative fees to trading fees, it’s important to understand why each charge is necessary. It’s also a good idea to annually benchmark your mutual funds’ performances against other mutual funds. If your fees are higher or your returns are lower than the average, it might be time to talk with your broker or adviser about the benefits of reallocating some or all of those funds into a different investment.
These are the main investment types that help individuals grow their wealth and prepare for retirement and other periods of life where money is needed. Some of these assets are easy to manage and sell while others require a lot of oversight but may yield a higher return. For clarification on any of these points or to understand what mix of investments is right to grow and sustain your income, we recommend consulting an experienced professional about your goals and willingness to be exposed to risk.
Did you know you can sell all or a portion of a life insurance policy, even term insurance?
Selling an unwanted life insurance policy is no different than selling your car, home or any other valuable asset that will create immediate cash.
Contact us today to learn more.
This article was written by Leo LaGrotte from Life Settlement Advisors
As the Founder, President, and CEO of Life Settlement Advisors, Leo has spent more than 18 years working in the life settlement and viatical settlement industry. Leo’s career began as an investment advisor, operating his own independent firm for seven years. Through his work as an investment advisor, and as the President of Life Settlement Advisors, Leo has gained a broad knowledge of investments, life insurance, and the analysis and pricing of life insurance policies.