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Investing

Investing Options Overview

If you are just beginning to invest, you might be wondering what the different options are. This article will give an overview of the most relevant investment options for you, but this is not meant to be a complete list. Which investment option or mixture is right for you, depends among other things on what return you are aiming for, your investment time horizon, how much risk you are willing to take and how much time you are willing to spend researching. I deliberately try to avoid using too many technical terms. For more precise explanations I recommend using Investopedia.

Stocks

You can buy parts or “shares” of publicly-owned companies, which are being traded on stock exchanges. By doing so, you will own a small piece of that company. A company issues many shares, and each share has a price. The sum of the price of those shares is how much investors think the whole company is worth (market capitalization). The price of a company depends on how much it earns, if it is growing its earnings, how much cash, debt and assets the company has, the overall economic outlook and many other factors. So if you buy shares of that company at a certain price and the company is able to increase its value, you might be able to sell those shares at a higher price. In addition, some companies use part of their earnings to pay investors dividends. Usually, these dividends get paid once every quarter (i.e. 4 times per year) and over the timespan of one year they amount to about 1 to 5% of the share price.

Buying stocks has a high reward potential, but also a relatively big risk compared to other investments. This is because your investment is entirely dependent on the future of one company. If it goes bankrupt, you can theoretically lose everything you invested. Therefore, you should research the company carefully beforehand, which can be time intensive.

Summary:

  • Stocks = parts of companies
  • Risk & reward: high, depends on performance of company
  • Research: very time intensive
  • Minimum investment: share price, unless you buy fractional shares
  • Fees: order fee and spread for buying and selling
  • Time horizon: very different (day trading, swing trading or investing for multiple decades)

Bonds

Companies and governments can issue bonds. Investors who buy those bonds effectively loan money to an organization. This money is then listed as debt on their balance sheets. On the end date, this organization has to pay you back what you invested. In the meantime, they pay you interest on the money they owe you (sort of like dividends). Bonds are basically reverse loans, because in this case investors are the lenders. There is a complication though: bonds also have a price. It could be higher than what is paid back at the end because investors trust the bond issuer. Because of the interest, investors will still make a profit on their investment, but the return on that investment (“yield”) is not as good. On the other hand, the price could be lower that what is paid back at the end date, which increases the yield. The interest always remains constant. You can buy or sell a bond at any time and it is possible to make a profit or loss from the difference in price as well.

Bonds provide a fixed income and an assurance of how much is paid back on the end date, which is why they are considered to be less risky. The only risk is that the bond issuer might not be able to back its debt, in which case you could also lose everything you invested. That is why it is important to choose stable organizations which you think will be able to pay their debt.

Summary:

  • Bonds are loans to companies or governments with an end date and a fixed interest
  • Risk & reward: low. Only risk: bankruptcy of bond issuer
  • Research required: some, but not as much as stocks
  • Minimum investment: depends on bond
  • Fees: order fee and spread for buying and selling
  • Time horizon: until end date (a couple of years) or less

Actively Managed Funds

Funds offer the possibility to let a professional institution actively manage your investment. They will invest your money in a mixture of different investments. Because of this diversification, funds are less volatile and less risky than buying individual stocks. But there are management fees of usually 1 or 2% per year, which is more than it might seem at first. Also very few funds have outperformed the overall market. This is why Warren Buffett placed a bet that “including fees, costs and expenses, an S&P 500 index fund would outperform a hand-picked portfolio of hedge funds over 10 years”, which he won.

Summary:

  • Actively managed fund = let a professional invest your money
  • Risk & reward: low, because of diversification
  • Research required: very little
  • Minimum investment: depends on fund
  • Fees: order fee + high management fees
  • Time horizon: like stocks, but usually used more by long-term investors

Exchange-traded Funds

Exchange-traded funds, or ETFs, are a grouping of stocks, sort of like mutual funds. But unlike mutual funds, this group of stocks is not being actively managed and they are being traded on an exchange, just like other stocks. An ETF can consist of any collection of stocks. Many ETFs track an index like the S&P-500 or Dow Jones, which means that the composition of stocks in that ETF is set to be the same as in that index. Other ETFs focus on specific areas, like investing in sustainable energy, developing economies or dividend paying companies. Some ETFs reinvest those dividends, others pay the dividends out directly.

ETFs also reduce risk through diversification, but they have a lower fee since they are not being actively managed.

Summary:

  • ETF = collection of stocks
  • Risk: low, because of diversification
  • Research required: very little
  • Minimum investment: trading price of ETF, which is usually affordable
  • Fees: order fee + low running fees
  • Time horizon: like stocks, but usually used more by long-term investors

Real Estate

This is an article is for people who are just starting to invest, so I will mention this only briefly. Buying an apartment or house generates a return in the form of rent and value appreciation (or loss in the form of repairs and depreciation). However, you need a lot of capital and credit-worthiness to start investing in real estate.

  • Risk: very low
  • Research and maintenance: extremely time intensive
  • Minimum investment: 5 figures
  • Fees: often 6% commission, interest on loan, repairs, etc.
  • Time horizon: decades

Cryptocurrencies and Precious Metals

Another option is to buy cryptocurrencies like Bitcoin or Ethereum (e.g. on Coinbase or Bison) or precious metals like Gold, Silver or Platinum. The idea is that these resources are limited and therefore can be trusted as a store of value. Additionally, increasing demand and decreasing supply could lead to rising prices. However, these are not real investments in the strict sense. Companies and real estate have an inherent value as assets with a return: earnings and rent. The value of metals and cryptocurrencies is that they can store wealth and be used as a currency. However, their price depends entirely on how much other people are willing to pay for it, because they do not generate any value on their own.

It can still make sense to own some cryptocurrencies and metals though in my opinion, which I share in another article.

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