Investments got you puzzled? (What the heck is a stock, bond or mutual fund?)

One of the questions many women investors ask is: “What’s a stock, bond, mutual fund, and how do I use them in my portfolio of investments?” They also say, make it simple, easy to understand, and don’t make me feel stupid when I’m reading it. I hear you! You want to know enough to ask intelligent questions and even start investing on your own!

This is a great question so I wanted to dive deeper into this conversation. My goal is to give you more information so you have a better understanding of what each is and how you can use them without fear and trepidation. 

I love this quote by Jane Bryant Quinn: “It’s a fact. Stock investors sometimes lose money on their way to wealth. Get over it.” 

You control the volatility (up and down value) by diversifying your asset allocation,(mix) of stocks, bonds, and cash. Of these three, stocks are the riskiest, bonds a little less risky, and cash is safe. This is where you balance your return and the amount of risk you’re willing to take. (I’m not going to address real estate and commodities in detail here.)

There are a total of five asset (investment) classes which include:

1. Stocks
2. Bonds
3. Real Estate
4. Cash
5. Commodities

That’s it! Only 5 asset classes. And it gets simpler. Let’s break them down into two categories.

1. Own
2. Loan

Let’s discuss each Asset Class in one of the two categories:

1. Stocks – Own – Companies that sell stock to shareholders are called public companies. When you buy shares in a company, you own a piece of the company. Some companies share their profits with investors/shareholders through dividends.
2. Bonds – Loan – Companies borrow your money and promise to pay you, the bondholder, back in full at an agreed upon time plus interest on the loan.
3. Real Estate – Own – You buy houses, apartments, office buildings or raw land. Real Estate is not very liquid so it takes time to convert your investment into cash. Technically, you don’t count owning your own home as an investment. You don’t want to have to sell if you need money.
4. Cash – Loan – You typically lend it to the bank and get interest in return for their use of your funds. This is in the way of savings, certificate of deposits, treasuries, and money market funds.
5. Commodities – Own – These are tangible products like gold, oil, wheat, which are bought or sold on various commodities exchanges. They are very risky.

Respect the Time Factor: No one knows what the market is going to do, except it will go down and it’ll go up. So stack the odds in your favor. Here’s a general guideline:

1. Money you’ll need in 1-3 years – put into cash
2. Money you’ll need in 3-10 years – put into dividend paying, large stocks; high rated A bonds; and cash
3. Money you’ll need in 10+ years – put into stocks, real estate, commodities

If you don’t know when you’ll need the money, err on the safe side.

Average per Year Historical Investment Returns for 1926-2020:

3.0%        3.5%            5.7%            10.19%

Inflation        T-Bills        LT Bonds        Stocks

These are long term historical averages which means, you’re investing for the long-term and they are averages. Like a good girdle or spanx, it can hide a lot of jiggles. In any individual year, any of these categories can fluctuate better or worse than the average. “Historically, it has paid to own stocks because 74% of the time, the U.S. equity (stock) market has posted calendar year returns above zero!” (Russell Investments)

Let’s talk about the mechanics of investing.

There are two ways most people invest in stocks:

1. Individual Stocks – buy a piece of ownership in an individual company by selecting the stock you want to buy at a specific price. You are responsible for deciding when to buy and sell your shares of stock.
2. Mutual Funds – hiring someone else (fund manager) to buy a “basket” of stocks for you. A mutual fund is a bucket of money that is used to purchase individual stocks on behalf of the people who contributed the money. The benefit of this approach is that with a relatively small amount of money you can get pieces of ownership in many different companies (diversification). This helps lower your risk and involves a lot less work on your part in researching individual companies to invest in.

Mutual Funds come in two types:

1. Actively Managed Mutual Funds – Professional fund managers use different strategies to decide what stocks to buy and sell in their respective mutual fund each day. There are more than 7,000 such funds in the US today. You are essentially betting on the skill of the professional fund manager. There is a cost for this management ranging from .50% to 2.5%. Here’s an example from Warren Buffet about what an impact a 1% fee can have.Buffett made his first investment in March 1942 (when he was 11 years old!). In the 78 years since then, the S&P 500’s value has increased 5,288 times over, including reinvested dividends — turning a $1 million investment into $5.3 billion.But if the exact same investment, with the exact same returns, was managed by an advisor taking a 1% annual management fee, the gain would have been cut in half. In other words, paying a seemingly small 1% fee would have cost this investor a staggering $2.65 billion.Fees matter. If you pay them, make sure you’re getting your value!
2. Passively Managed Index Funds – The basket of stocks is decided up front – the index it is tracking. There is not a lot of daily buying and selling because it mirrors the index. You are investing in stocks as an overall investment category without trying to bet on the skill of an individual money manager. Index funds have historically done better than more than 80% of active, professionally managed mutual funds.

If you want to keep your life simple (Marie Kondo anyone?) use index funds to invest in stocks.

Another advantage of Index Funds is their cost. They are much LESS expensive than actively managed mutual funds, averaging 0.09%.

So keep it simple: For money you don’t need to spend for at least FIVE years, put it in an S&P 500 Index Fund.

3. Passively Managed Exchange-Traded Fund (ETF) – Static Basket of Stocks, traded all day long like a stock. Cost of trading is a commission each time you buy or sell. They are more expensive than Index Funds, 0.44%, so recommend Index Funds over ETFs unless you want more complexity in your portfolio.

Investing in Bonds is very similar:

1. Buying Individual Bonds: You lend your money directly to a corporation or municipality and obtain their promise to pay a stated interest rate, and coupon payments usually every six months,  with a guarantee to repay your principal at a specific time. Bonds come in a variety of terms, 30 days to 30 years. Shorter term bonds pay less in interest and longer term bonds usually pay higher interest rates.
2. Mutual Bond Funds: You invest your money in a “basket” of bonds that are bought and sold by a mutual fund money manager. You rely on the manager to pick bonds in keeping with the mutual funds objective (short term or long term income). In return you pay a management fee and your interest is a combination of all the interest paid by all of the bonds in the mutual fund. The manager replaces maturing bonds with new bonds, so the mutual fund does not terminate with the maturity of any given bond.
3. ETF Bond Funds: Bond ETFs offer many of the same features of an individual bond, including a regular coupon payment. Since Bond ETFs hold assets with different maturity dates, at any given time some bonds in the portfolio may be due for a coupon payment. For this reason, bond ETFs pay interest each month with the value of the coupon varying from month to month. An investor’s initial investment is at greater risk in an ETF and mutual fund than an individual bond. Since a bond fund never matures, there isn’t a guarantee the principal will be repaid in full.

Generally speaking, when saving for retirement, stocks are appropriate for most people up to age 50. By then you should start adding bonds into your portfolio to lessen the volatility and start preparing for retirement. There are many different models illustrating how to allocate your money based on your age and the amount of risk you’re willing to take on. As I’ve shown you above, historically speaking, you’ll get the most growth and return out of your stock portfolio. Your bonds are more like the foundation of your portfolio.

A general guideline is for women to invest in stocks equal to 110 or 120 minus your age. So 120-50=70% of your investments in stocks. If you are a risk taker, then keep more invested in stocks. Bonds and cash equivalents are appropriate for the other 30% of your portfolio. This helps you transition to a more conservative portfolio as you approach your retirement, because you are growing your investments as you prepare for retirement. Then you will draw income off your investments in retirement when you want a more stable portfolio.

Personally, I like stocks, and still have 90% of my portfolio in stocks. It’s an individual decision, but you have to be aware of the risks associated with it.

What’s Holding You Back?

Women NEED to Invest because investing helps close the gap:

1. We still only make 80 cents on the $1.00 compared to men.
2. We dip in and out of the workforce taking care of kids and parents.
3. Women’s average balance in 401(k) is 50% less than that of men.
4. We live longer, 5 years longer on average, than men.

Investment Obstacles:

1. You don’t want to do something you don’t understand. The only way you’re going to gain confidence is by doing it. Doing it helps you understand it. Take one small step at a time and keep it simple.
2. You don’t want to lose money. Investing is not a competition (like trading) no one has to lose. If you invested your money in the S&P 500 over the worst thirty-year period in history, you would still have made about 8 percent/year.
3. You think investing is the same as gambling. It’s not and here’s why. Gambling is wagering your money on a particular outcome. If your lottery numbers aren’t called, you lose out. Investing is buying something which has value. Over time that value can go up or down, but by diversification and investing over time, you greatly increase your chances of making money, not losing it.
4. You don’t trust the financial industry. You need to shop smart and find a firm or online brokerage that you want to work with. There are many choices, and I’m happy to recommend a few.

I’ve given you an overview of stocks, bonds, mutual funds and ETFs. You’ve already taken the first step by learning more about this topic. Now start saving, however small. Your future you will thank you!

Please join our private Facebook Group, Women Talk Finances, where we will continue the discussion on investments.

If you still have questions, feel free to schedule your free 20 minute discovery call with me.