Investing Summer School: Understanding the 5 Most Common Ways to Invest
All this week, we're running a series on basic investing lessons, trying to give novices the information they need to invest their money and make it work harder for them. We opened Monday with the basics on finding ways to save more to put toward your investments.
Today, let's turn to some of the most popular investments that people choose, along with some tips on whether they're right for you and how to use them.
1. Mutual Funds.
Many investors start with mutual funds for a simple reason: They give you a well-diversified investment portfolio even if you only have a modest amount of money.
Mutual funds collect a big pool of money from many investors and then invest that money collectively, giving you shares that correspond to the amount you invested. You then share in the gains or losses of the fund's investments. There are all kinds of mutual funds -- ones that buy stocks, bonds, and many other investments, including ones that are focused solely on an industry or companies that operate in a particular country.
You can buy mutual fund shares in two ways, either directly from the company that manages the fund or through brokers that offer large menus with hundreds or even thousands of mutual funds.
Mutual funds are a great way to get started investing. Many funds allow you to buy shares at no upfront cost and with minimum investments of as little as $100 if you commit to an ongoing investment plan.
Investing in individual companies' stocks lets you sharpen your investing focus.
Shares of stock represent an ownership interest in a particular company, giving you the right to share in dividend payments and to vote on certain corporate matters, including naming a board of directors to run the company and approving big corporate events like mergers.
If the company's business performs well, the stock usually rises over the long run. But if the company struggles, then your shares can lose value.
Some companies offer their stock directly through direct investment programs, but most investors trade stocks using brokerage accounts. You'll pay commissions to buy and sell stocks, but discount brokers charge more modest amounts that make stock trading accessible even to those with limited funds to invest. But we recommend caution: Your odds of doing better picking stocks on your own than buying a good index fund aren't that high. (Here are a few reasons why.)
Investing in bonds also involves choosing specific companies and other bond issuers, but the investment relationship is different. With bonds, you lend money to the bond issuer in exchange for the promise of receiving interest payments periodically and having your investment repaid in full when the bond matures.
Bonds typically offer lower returns than stocks, but they also have less risk of total loss, as even if a company goes under and declares bankruptcy, bondholders are first in line to get paid, ahead of stock investors. Some issuers offer bonds directly, including the U.S. Treasury and major corporate issuers. For many bonds, though, you'll need a brokerage account to get access.
4. Exchange-Traded Funds.
ETFs are hybrids, combining aspects of mutual funds and stocks.
Like mutual funds, ETFs are pooled funds that hold many different underlying investments. Like stocks, though, ETFs trade through brokers on public stock exchanges throughout the day. By combining appealing traits of both stocks and mutual funds, ETFs have gained in popularity in recent years.
Brokers generally charge the same commissions for ETF trading that they do to buy and sell stocks. However, many brokers now have lineups of commission-free ETFs for their customers. The lack of commission can make a big difference in whether it makes sense to invest in ETFs or individual stocks, especially if you don't have huge amounts to invest.
Commodities are physical objects that have value, including everything from precious and industrial metals to agricultural and energy products. With some commodities -- especially gold and silver -- it's easy to take physical possession of the object. For others, most investors use alternative investments that don't require taking possession of the physical goods involved.
Depending on the type of commodity, brokerage accounts often allow access to commodity investing. Moreover, ETFs and specialty dealers can give you exposure to certain types of commodities.
Finding The Right Mix
Even though you should know about all of these investments, you don't need to invest in all of them.
For beginners, a basic mutual fund or ETF is likely the best entry point into investing. As you learn more and get more comfortable, branching out into individual stocks and bonds, as well as commodity investments, can help you round out your portfolio.
In our next lesson, we'll cover some basic strategies to help you decide how to divide your money among these different investment areas to come up with the best long-term results.
Dan Caplinger is a Motley Fool contributing writer and the author of The Motley Fool's brand-new special report, "Your Essential Guide to Start Investing Today." Sign up to receive your copy today -- it's absolutely free.