3Notes: Investing 201 Pt 1 – Investment Types


So we had a previous discussion on building a portfolio in accordance with God’s word, but let’s take things a bit further. The key to long-term investing success is a solid foundation. Let’s lay some more of this foundation by looking at investment types.

Types of Investment Vehicles

Stocks are shares of a company, which make you part owner upon purchase.  Some general rules to stick by: Buy low, sell high; pick quality businesses with a track record of success. People are bad at picking stocks because they don’t do their homework. Do not buy stocks that are hot on the premise that “it’s on the way up, I better buy!” Consider what you normally consume and consider investing in that (Clorox, Johnson &Johnson, your car maker, to name a few). Why aren’t you buying when these stocks get cheap? Since individual investors so often select the hot stock instead of the quality stock, they violate the very rule of buy low, sell high ALL THE TIME. Retrain your mind to look for the deals.

Bonds and bond equivalents are theoretically the most secure investment vehicles available to us. At the highest level, you have Treasurys in durations as little as 4 weeks (T-bills), to 1-10 years (T-notes), to 10+ years (T-bonds). U.S. Treasurys are considered the safest investments in the world, called “risk-free”. Those near retirement or risk-averse, U.S. Treasury’s are great for earning interest on money beyond banks’ currently offerings (.05-1.05%). However, a principle rule of investing is reward for risk level. So if U.S. Treasury bonds are risk free, this means? Low returns.

Other Bonds

So what options do we have for higher return? Municipal bonds are a solid option here. Referendums on issuance of bonds for fire departments, police, or hospitals occur on ballots or as a result of public works or city council meetings. These bonds hold some additional risk (states don’t print money like the U.S. can), but they are also relatively safe. Unless you lived through Sacramento or Detroit’s recent bankruptcies, you can count on these bonds paying out, TAX FREE.  We then move down to junk bonds, which offer high yields but also the commensurate default risk. You not only can find corporate and municipal bonds here, but also several sovereign bonds and some corporate bonds. Buying bond exchange traded funds (ETFs) is another good way to get exposure. Fund managers like Vanguard have extensive bond ETF portfolios.

Pooled Fund Investments

Fund investments, like mutual funds and ETFs, pool the funds of many investors to achieve a common theme/goal.  Mutual funds pool the money of several investors to achieve some theme or thesis and their net asset value is recalculated at the end of each trading day. Mutual funds are actively traded, charging higher fees than other pooled funds. ETFs typically mirror some index (e.g. S&P 500, Nasdaq 100) by holding the same proportional weights of investments and are passively managed, meaning lower fees. ETFs revalue in real time.

Hedge funds use some sort of hedge (read about hedges in the Glossary) to protect the fund while pursuing some highly specialized strategy. These funds typically outpace other investment vehicles in “risk-adjusted performance” because they offer downside risk protection. Venture Capital funds invest sums of money in upstart businesses in the hopes of growing on some time horizon, usually less than 5 years, and either selling the stake or cashing in on some public offering. Private equity is an investment firm that pools investor cash with mandated holding periods to allow investment into private businesses. The PE looks to hold the investor cash long enough to turn a profit on businesses with the promise of cash back with interest to its own funders.

Alternative Investments

Options are exercised on stocks and bonds. I won’t go too deep into this, but basic options are puts and calls. Puts are bets that a stock will fall. You pay the put price for the option to sell a stock at a lower price, earning the difference. If the stock price is higher, you do not exercise the option, losing just the fee. On the flip side, if entered into a call contract (betting price increase), you buy the option to receive the stock at the higher price, collecting the difference. These options are for more advanced investors.

These are the basics for investment types. Check back in a couple of days for information about investing strategies.

-Joe

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