If you were asking someone to explain investing to you like you’re 10 years old, this is for you. We’re going to run through the basics that everyone needs to know in order to get on the path to financial independence.
Stocks
When a company goes public, that means they are allowing anybody to invest in their company. Anyone can buy shares of that company, aka stocks, and in return they benefit from that company’s profits and growth. As that company becomes more profitable, the shares grow in value. In addition, some companies that have leftover profits may distribute these to shareholders in the form of periodic dividends. Stocks are often called “equities” because you literally own part of that company’s equity.
Bonds
Bonds are essentially debts or loans that are paid by companies or the government to the investor. When you buy a bond, the government, or company, agrees to pay interest for the set duration of the loan. These are sometimes compared to I.O.U.’s. Just like loans, bonds come in varying timeframes – short, intermediate, and long term. Because bonds pay a guaranteed amount of interest or “yield,” these are considered fixed income assets. The value of the bond itself can change if demand for it changes. For example, if stocks go down, investors may look to bonds for the guaranteed safe return, which may drive the value of bonds up. Conversely, when stocks go up, there is less demand for bonds, and the price may fall.
Mutual funds
Mutual funds are groups of stocks and/or bonds. These are managed by a fund manager that decides what kind of assets to include in the fund. Funds are designed with different investment goals in mind—whether it’s investing in high growth companies, small cap companies, government bonds, there is almost a limitless variety of mutual funds to choose from depending on the investment goal. The tradeoff is that these funds charge management fees that can sometimes be substantial. Sometimes these funds have a minimum investment amount.
Index Funds
In the 1970s, a man named Jack Bogle, the founder of Vanguard, released the first index fund. An index fund is a type of mutual fund that tracks a specific index, or sector, of the stock market. The first index fund, and still the most popular, is the S&P 500 index fund that goes by the ticker symbol VFINX. When you invest in VFINX, or any other S&P 500 index fund, you essentially own a tiny piece of every S&P 500 company. The reason why these funds are so popular over traditional mutual funds, is that you are able to diversify across the entire index, and the management fees are very low because there is minimal amounts of active management going on. We’ll talk more later about why index funds have changed the investing world and why they are a powerful tool to have in your investing toolbelt.
ETFs
You’ve probably heard the terms “index funds” and “ETFs” used interchangeably. An ETF, or exchange traded fund, is essentially an index fund that sells shares on the stock exchange. For example, VTSAX, which is Vanguard’s total market index fund, can only be bought directly through vanguard. However, vanguard offers essentially the same index fund on the stock exchange called VTI. Because it’s sold on the exchange, you can buy this from any brokerage account, like I do on Fidelity, even if it’s not a Vanguard account. There a lot of other small differences that we’ll get into in another article, but essentially I think of ETFs and index funds as the same type of investment, just bought in a different way.
Real Estate
You can make money in a variety of ways with real estate, largely varying from direct and active ownership to passive investing. At its core, it is simply owning a building and having tenants pay you rent. There are a plethora of strategies on how to make money in real estate. Even in direct real estate ownership, there are long-term rentals and short term rentals, both of which are very different. Besides direct real estate ownership, there are also ways to make this more passive, such as investing in a syndication, direct lending, or Real Estate Investment Trusts (REITs). We’ll get more into real estate investing in future posts.
Commodities
These are things like gold, silver, oil, energy—resources that are traded based on their demand. Remember when lumber was crazy expensive during Covid? The most common way the average person invests in commodities is by buying actual gold. Sounds medieval, but pretty cool. You can also trade commodities on a commodities platform, or buy commodity ETFs on your regular brokerage account.
Speculative assets
These are things like bitcoin, NFTs, artwork, Pokémon cards, beanie babies, etc. Investors buy these things in hopes that they will go up in value over time. Their value is entirely based on the popularity of the item. As we’ve seen in recent years with the Bored Ape Yacht Club scandal, these are highly risky investments since the items themselves do not produce anything, and its value is entirely dependent on demand. Some will argue that buying these items is not really “investing” but “speculating”.
Cash
Of course, there is cold hard cash. These days cash is able to earn you a pretty decent return just by holding it in a high yield savings account or money market account. Cash is the safest asset in the short term; however, holding cash is actually risky in the long term, because your buying power decreases over time thanks to inflation.
So there you have it, these are probably the most common asset types you’ll come across as an average investor. IMO, the most important to know about are stocks, index funds, bonds, and cash. If you understand these 4 assets, you’ll have the tools you need to retire early. In the next post, we’ll talk about the vehicles in which we hold these assets – types of investment accounts.