If you are having trouble making sense of all of the possible investment options, you are not alone. There are plenty of news articles reporting on the lack of financial literacy among adults even though economics and personal finance classes are part of the curriculum in many high schools. Unfortunately, adults over the age of 30 are not as financially literate as they think they are. A recent study showed that although 44% of respondents considered themselves to be very financially literate, only 45% of respondents could pass a basic financial literacy exam.
One of the challenges for investors is trying to understand all of the different asset classes and deciding which is right for them. Another challenge is picking the right investment within an asset class. The amount of information can be overwhelming, but there are professional advisors as well as social trading platforms that can help you make sense of the basic asset classes and investment options.
When people think about investing their money in the financial markets, stocks are usually the first kind of investment that comes to mind. A stock is an ownership right in a company. Some stocks give ownership rights in private companies that are not traded on a public market. Owning a stock in a private company does not mean that the stock is less valuable than that of a company traded on a public stock exchange. It does, however, mean that the stock has low liquidity and will be harder to sell compared to a stock that trades on an exchange.
The shares of stock for public companies sell on a public stock exchange. Therefore, it’s much easier to buy and sell these stocks. Public companies must adhere to strict regulatory guidelines related to information disclosure and financial reporting. Therefore, investors should only consider buying stocks for publicly traded companies. There are two ways that stockholders can earn money on their investment.
Dividend Yield – A dividend is a cash payment that a company gives to its stockholders. The average dividend yield for firms in the S&P 500 is around 2%. That means stockholders can expect to get a dividend equal to about 2% of the stock price. When a company pays a dividend, it returns part of its profits to the owners of the company (the stockholders). Companies that pay dividends usually disperse them quarterly, but other companies choose to pay dividends less frequently. Some companies don’t pay dividends at all. In general, older, more mature firms are more likely to pay dividends. Younger firms in high growth industries tend to reinvest profits rather than pay dividends to shareholders.
Price Appreciation – The other way that you earn money on a stock is through price appreciation. In other words, you earn money as the stock value increases. A stock’s annual price appreciation can differ dramatically from the market average, but over the past twenty years, the firms in the S&P 500 increased by around 12% annually. Stocks, however, can be a very risky investment. In 2008, the market had a return of -37%, and in 1995 the market had a return of +37%. Also, it would help if you did not forget that you haven’t realized a gain on your stock investment until you sell your shares of stock.
Bonds are a popular form of investment in which you own part of the outstanding debt. Financial institutions lend money to borrowers and then sell claims to that debt in the forms of bonds. The borrower may be a company or government. The total return you earn on a bond investment comes from a regular coupon payment (usually paid semi-annually) and any price appreciation over the holding period. If you hold the bond until maturity, you receive the face value of the bond. The yield on the bond is related to current market interest rates, the risk of the borrower, and the length of the bond’s term (longer terms usually require an interest premium over shorter-term bonds due to additional risk).
Investors who are closer to retirement or in retirement usually have a much higher portion of their portfolio in bonds compared to younger investors. The reason for this is that bonds provide a source of income through the regular coupon payments and have a low risk for negative returns. Recently, however, bonds have been a less popular form of investment. First, bond prices have an inverse relationship with interest rates. As market interest rates slowly increase from their historic lows, bond prices fall. Second, bond yields remain historically low. Over the past few years, investors only earned an average of 1-2% annually on government bonds and 2-3% annually on corporate bonds.
Mutual funds and exchange-traded funds (ETFs) are both managed portfolios of assets. Each mutual fund or ETF has a specific investment goal that leads to the fund manager’s decisions. Some funds invest in the best foreign stocks, some funds invest in bonds, and others seek to earn a return higher than the stock market. Purchasing shares of a mutual fund or ETF is a more cost-effective way for investors to fulfill their investment goals because they buy shares of the mutual fund rather than many individual investments. Plus, funds are less work for investors who don’t have the time and expertise that professional fund managers have to choose and manage the portfolio. ETFs differ from mutual funds because they have lower minimum investments, and investors can buy and sell shares on an exchange at the current market price any time during the day. Mutual funds usually have higher minimum investment requirements, and all buy and sell transactions occur at one price each day.
If you own a home, you already have an investment in real estate. Many investors prefer real estate investments because their money goes to a tangible asset. Historically, real estate has been a good investment because it is a relatively low risk and provides a rate of return of around 6-8%. The commercial real estate is also considered to be a natural hedge against inflation because tenant rental rates increase along with overall price levels.
If you are considering an investment in real estate, you’ll need to decide if you prefer a direct or indirect investment. Direct investment involves purchasing and managing the real estate. For example, you may own several rental homes, a shopping center, or an office building. These investments offer a higher potential rate of return but also offer much more risk and time. Also, direct investment in real estate is capital intensive and may prevent the average investor from holding a diversified portfolio. Indirect investment, however, involves purchasing shares in a company that owns and manages the real estate. Publicly traded real estate companies are usually organized as real estate investment trusts (REITs) that can be traded like stocks on an exchange. REITs typically specialize in a specific property type and region. There are also mutual funds and ETFs that focus on real estate investment.
Currency investments, along with options and derivatives, are considered some of the riskiest types of investments. As a result, most trading platforms limit who can invest in these asset classes. Cryptocurrencies, however, opened these markets to investors without the same types of restrictions and regulations placed on regular foreign exchange markets. Currency trading can be a way to earn a quick return on your investment, but it’s important to remember that possibility comes with a high level of risk. If you decide to invest in currency, you should keep it a tiny percent of your overall portfolio.
Now that you have considered the different benefits of each major asset class, you’ll want to get more information about specific investments in that asset class. Financial news sites provide headlines for companies, but for additional research, you can find detailed management and financial information from places like Yahoo Finance, Bloomberg, or the Wall Street Journal.
Online brokerage platforms also provide additional research for clients. One of the things that make eToro unique among trading platforms is that adds a social component to investment research. Clients can access charts, financial ratios, and analyst research about stocks and cryptocurrencies. Also, members can post their analysis and recommendations for others to read. Unlike merely reading an analysis on a social media platform, however, eToro members can check the investment performance of the people offering trading recommendations. That is a level of information and credibility you can’t find anywhere else.
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