If you’re new to investing, it’s normal to feel a bit intimidated. Making decisions about money is never easy, and the complex investing terminology alone can be overwhelming. Take a deep breath; we’re here to help! To make the topic of investing a bit more digestible, we’re going to break down some of the most popular investment options into easy-to-understand terms and help you get on your way to building a solid investment portfolio.
Stocks and bonds
You’ve probably heard of stocks and bonds before, but what exactly are they? Buying a stock means you’re purchasing a piece of the company and now have partial ownership. Stockholders make money in two ways:
- Dividends: This is when a company pays profits out to its stockholders.
- Appreciation of stock price: This allows you to sell your existing stock at a higher price point than you originally purchased it for.
Since the value of your stock depends on the company’s performance, this type of investment tends to be more volatile.
Bonds are also an investment vehicle, but they’re different from stocks in a few ways. Instead of owning a piece of a company, you’re lending money to a company or a government entity. However, purchasing bonds comes with a contract that says you’ll be paid back with interest over time. Because of this legal obligation, bonds tend to be less volatile than stocks.
Tip: When building your investment portfolio, split the allocation between stocks and bonds to strike the right balance between risk and security.
Diversification is the practice of spreading your investments around so that your exposure to any one type of asset or company is limited. In other words, it’s a way to make sure you don’t have all your financial eggs in one basket.
For instance, let’s revisit the idea of stocks and bonds. As we established in the previous section, stocks and bonds perform differently. The former is more volatile, which can lead to greater gains but also greater losses. The latter is less volatile, which leads to more stability but less chance of making a lot of money in a short period of time.
A great example of diversification is splitting your portfolio between stocks and bonds, based on your level of risk tolerance. Take a look at the chart below to see the outcomes of a balanced portfolio.
Tip: There’s no one-size-fits-all approach when it comes to building a portfolio. But this can make it challenging to figure out the right split between investments. Origin’s financial planners can help you identify your level of risk tolerance, create a target allocation based on this information, and recommend a portfolio that will get you to the stated goal.
Mutual funds and ETFs
Mutual funds are investment vehicles that make it easier to invest in thousands of companies at once. They accomplish this by pooling investor money to invest in securities like stocks, bonds, and various other assets. The benefit of mutual funds is that you only have to place one trade to buy into that fund, and the manager of that fund will purchase stock on your behalf. This naturally creates more diversification in your portfolio, which is also a plus! You can also choose which companies to invest in based on size or geographic location.
ETFs, which stand for Exchange-Traded Funds, work similarly. ETFs are a type of security that tracks an index, which typically measures the performance of a basket of securities. But the difference between mutual funds and ETFs is that the latter can be purchased or sold on a stock exchange the same as a regular stock.
Tip: Watch out for expense ratios, which can range from .01% to 2.5%. Every mutual fund or ETF has one, and it’s essentially a fee to the manager who places trades inside the fund on your behalf. If you’re using a more expensive fund, make sure they’re able to justify the fee they’re charging you. In general, it’s better to target funds with less than 0.5% expense ratio.
In addition to the more traditional forms of investments we explained above, there are alternative investment options that you may have heard about. We outlined some of the most popular ones today to help you better understand the impact they can have on your portfolio.
Cryptocurrency is a digital currency that operates on decentralized control, which means that a central authority does not regulate it. This is positive for many reasons: it provides more autonomy, saves on bank transaction fees, provides anonymity, and allows you to make purchases anywhere with internet access.
However, it’s important to remember that cryptocurrencies are based purely on speculation. This means the value of these currencies, unlike government-regulated currencies, is completely dependent on demand. So if people collectively decide one day that Bitcoin isn’t worth anything, your investments may end up with no intrinsic value. Cryptocurrency also has a high transaction fee (frequently up to 4% of the trade), heavy tax implications, and limited trading volume relative to stocks or bonds—not to mention it’s not accepted as payment in many places.
Options are financial instruments that are derivatives based on the value of underlying securities like stocks or bonds. An options contract offers the buyer the opportunity to buy or sell the underlying asset on the public stock market, although it’s not required. There are two types of options to be aware of:
- Call options: the option to purchase stock at a certain price by a specific date.
- Put options: the option to sell stock at a certain price by a specific date.
Options tend to be risky investments because they require many factors to be aligned, from the exact timing to the stock price, to profit.
Commodities are tangible goods that can be bought and sold. This can include anything from agricultural produce to oils to precious metals. When you invest in commodities, you’re essentially speculating where the future price of the tangible product will go, as well as how the supply and demand will pan out.
While investing in commodities can add diversification to your portfolio and hedges against inflation, they’re more prone to market volatility since they can be affected by world events and government regulations. Also, keep in mind that commodities like gold, oil, or wheat don’t make money the way companies do and therefore don’t increase in value over time. That’s why we generally recommend investing in stocks over commodities.
Investing in real estate requires you to purchase, manage, and rent or sell a piece of real estate for profit. This type of investment can be beneficial because real estate value tends to appreciate, and you’ll likely have a steady cash flow from the money you’re making through rentals or sales—plus, there are tax benefits to this form of investment.
However, there’s a high barrier to entry for real estate investing since it requires a big chunk of money upfront. Real estate is also a time-consuming, long-term process that’s not suitable for everyone. There's also limited liquidity with real estate and exposure to unique risks like natural disasters or damages done by tenets. You should also keep in mind that, while real estate in the U.S. tends to appreciate, it’s not a guarantee. If there isn’t enough demand for real estate in your area, the value of your investment drops drastically.
Tip: If you want to dabble in any of these alternative investment options, limit your exposure to less than 10% of your portfolio to minimize risk.
Investing doesn’t have to be a scary process. Use this information to establish the foundation of your investing knowledge, then partner with your Origin financial planner to start building your portfolio. If your company doesn’t have Origin as a benefit yet, ask your HR team to request a demo with us.
Note: The information provided on this page is for educational purposes only. Please ask your financial professional for specific guidance on investing.