Disclaimer: The advice provided in the Financially Fit series is general advice only. It has been prepared without taking into account your objectives, financial situation or needs.
If you were not living in a hole on Monday and did any of the following: (a) turned on your TV to any news source, (b) listened to the radio, (c) were on the Internet in any capacity, or (d) were breathing, you probably noticed that it was a bad day for investors. I woke up on Monday morning to a text that simply read, “it’s gonna be a bloodbath.”
So I went to my favorite news source (Twitter) and trolled around looking at #BlackMonday. I had a bleak moment of hope that it meant sales like #BlackFriday – but no such luck. However, it depleted my bank account to the same effect as a shopping spree day would.
So what happened exactly?
China is in the middle of a stock market crash as there is now considerable skepticism about China’s growth. As the government controls a lot of information going in and out of China, it’s difficult for investors to tell what’s really going on, but all signs point to “not as good as we expected.”
Why did that affect us over in ‘Merica?!
China is the second largest economy in the world. We live in a very connected world (a global economy) so when one major area takes a hit or slows down, it will slow down markets everywhere. AKA: for better or for worse, we’re all in this together.
What does this mean for you?
You might have noticed some of your investments tank. There might even be more movement downwards in the next few days or weeks (yes, you might see a little more red).
Two weeks ago, Colleen Nolan (CPA, financial advisor and all-around awesome person who works in Baird’s LND group) told us that even though there is risk and volatility in investment, the markets tend to move upwards over time. And she sent out a much-needed reminder to me this week which stated, “having a financial plan and sticking to that plan helps keep temporary market volatility in perspective. Investors focusing on saving, asset allocation investing and planning are better able to achieve their financial goals.”
Said a different way: keep saving, keep investing, shake it off like Taylor Swift because (in the long run) it’s all gonna be alright.
Today we’re going go to through some investing options: stocks, bonds, mutual funds and ETFs. There are other options out there, but for now we are going to keep it simple.
What are Stocks?
“Stocks are scary.” Someone recently e-mailed me that as a question for Financially Fit. Notice’it isn’t a question. But, as ‘Black Monday’ shows us, stocks can definitely be scary!
A stock is essentially buying a small piece of a company. When you buy shares, you become a co-owner of a company. And as an owner, you have a right to the profits it generates (usually in the form of a dividend). Also, if you pick a good company to invest in, you will profit as the company grows in earnings and gains a higher valuation. For this reason, you should look to invest in companies that stand for solid business practices and have a vision you believe in.
Pros: Stocks can generate great returns and lead to wealth over time with a good plan in place (e.g., with high risk there can be high reward). It is also relatively easy to invest in stocks once you have picked out what you would like to invest in.
Cons: I’m here to tell you, stocks have risks. They are not a magic answer to instant wealth. You might need to do a little more research in order to properly diversify your portfolio and to make sure you are taking on the amount of risk that is right for you. There are also trading costs to stocks which vary depending on which brokerage you use.
What are bonds?
Bonds are effectively you lending money to a company or the government. That company (or government) is in debt to you (that’s right, it’s the other way around, suckers!). In return, you get payments of interest over time and eventually the money you put in gets returned when the bond matures.
Pros: You can predict the cash flows you will be getting from the company/government and they are generally safer investments (unless they are “junk” or “high-yield” bonds – those, as they sound, are more risky – but also pay a higher interest for taking that risk).
Cons: If you buy safer bonds, you are less likely to make a lot of money on them (than, say, stocks), and there will always be a risk that the issuer of the bond defaults and doesn’t pay you back (no matter how many times you e-mail them the link to Rhianna’s “B**** Better Have My Money” music video).
What are mutual funds?
You may have noticed a theme when people talk about investing. And that theme is: diversify! Mutual funds are a simple way to invest in a portfolio of investments that is already diversified based on a certain risk tolerance. For example, you can buy into a mutual fund that holds 500 stocks. Mutual funds are often “actively” managed by a (hopefully) smart financial guru who chooses investments that he or she believes will provide the best return.
Pros: Diversification, simplified. It also doesn’t cost too much to purchase a mutual fund, with many requiring initial purchases of around $1,000-$5,000. You can then set auto-investments to add in money over time (say, $50-$100 every month), making investing easy.
Cons: It might take time to gather the money for the initial purchase into the mutual fund if you are just starting out saving. There are often fees associated with purchasing these funds as they are actively managed by a fund manager. There are, however, cheaper options with lower fees (called “passive” index mutual funds. Google ‘em).
What are ETFs?
ETF stands for “exchange-traded fund.” Think of them as a combination of mutual funds and stocks. Like mutual funds, they pool together different investors’ money to buy a diversified portfolio of stocks and/or bonds. Like stocks, you buy shares of them through a brokerage instead of from a fund company.
Tip: say “ETFs are so hot right now” at your next family party and your rich uncle is bound to be impressed.
Pros: They add more diversification than individual stocks and there are a lot of options. It is relatively easy to invest in an ETF (just as easy as it is to invest in an individual stock through a brokerage). It can also be more cost-effective than actively-managed mutual funds.
Cons: You still need to diversify and do your research as many ETFs are almost stock-like in the way they invest (some may just follow stocks in a specific industry). ETFs follow a wide variety of investing strategies and use different rules that aren’t as traditional as other investments may be – which may lead to greater risk than a mutual fund or bond.
Invest on, friends.
As always, feel free to add in your input (or questions) in the comments – or let us know what you’d like to hear more about. I’m learning, too!