Investing 101

Investing 101

This is my crack at trying to sum up investing in a relatively small post. This is not all-inclusive and is off the top of my head, taken from my experience in investing thus far. There are some other really great bloggers out there with more comprehensive and in-depth posts on this topic, but I thought I would try and add my own twist to things.
The number 1 most important, first step, to investing is: making the conscious decision to SAVE money. If you have no money to invest, it is a waste of time reading or learning about it, saving money is the key. I would suggest starting by making a budget or really thinking about your personal finances. I think it will take a whole blog post to talk about this, so that will be my next topic I post about — until then, feel free to read on.

What is investing?
Well it is basically a term used for putting your money into anything you think will return a positive future economic benefit. This is a very broad definition for a reason because it is a broad term which can be used to describe most things people put their money into. Some things that may be considered as investing are: secondary education, vintage cars, various types of art, stocks, bonds, mutual funds, etc. You may ask, why would secondary education be considered an investment, or vintage cars? Well people taking secondary education programs generally expect to have a higher income than if they did not take the program; therefore, they are expecting a future economic benefit of having more money later in life. The same idea applies for vintage cars, or art, most people that purchase these items expect their value to increase over time, returning a future economic benefit. I have no experience with vintage cars or art, these items are out of my price range so my experience is with mutual funds, ETF’s, and stocks. The investment vehicle’s I have experience in are a lot less expensive, and are obtainable by everyone, which I will cover in this post.

What is “The Market”?
When people say “the market” they are usually referring to a specific stock market. The main stock markets in Canada and the United States are: NYSE (New York Stock Exchange), TSX (Toronto Stock Exchange), NASDAQ (National Association of Securities Dealers Automated Quotations; I had to look this one up), and the “Dow Jones” (DJIA; Dow Jones Industrial Average). There are more I am probably forgetting but those are the most popular. There are a lot more across the world, but they are usually expensive to trade on from Canada (and I am assuming the United States as well) depending on what type of account you invest in.

What are Mutual Funds?
Mutual Funds are investment vehicles that are usually managed and consist of money received by a large group of people. So basically your “funds” are pooled with other people’s “funds” to buy stocks and bonds on various markets. You can contribute a lump sum, or make payments into the fund, or a mix of both. Some funds require a minimum lump sum amount to invest, and then anything over that can be made in payments. Some things to note about mutual funds: they charge fees and they do not have the freedom of other investments. The fees they charge are usually annual fees for managing, even if the fund loses your money, as well as back-end exiting fees for leaving the fund. The back-end exiting fees usually go down the longer you stay within the fund, but they usually never completely disappear. Never put your money in to 99% of mutual funds. The reason for this is the fees and the lack of freedom to hedge against bad economic times; most people lose money in mutual funds.

What are ETF’s?
ETF stands for Exchange Traded Funds; these are very similar to mutual funds but are not exactly the same. The ETF can be opened or closed, closed ETF’s have a finite number of “pieces” that can be bought and sold at any given time; all ETF’s usually trade at a premium (higher) or a discount (lower) to their NAV (Net Asset Value). There are a lot of ETF’s out there, and most try to track or exceed a specific market or benchmark, but the idea is the fund has a specific goal, like tracking the S&P 500. The ETF will use the money to purchase shares of a bunch of different companies to achieve what they are trying to track; so in essence you are buying a share of the share of all the collective companies combined. You may be asking yourself “why would I do this and not buy the shares myself?”; well, for a couple reasons: you may not have enough money, you may not have the time to re-balance the portfolio as often as needed, and the commissions charged on your account could become quite high (assuming you are charged per trade like I am). Those are a couple of reasons off the top of my head as to why it could be advantageous to buy an ETF, another big one though is to achieve a more diversified portfolio with smaller amounts of money. However, as with mutual funds, ETF’s always have fees attached to them so beware of high fee ETF’s — the lowest fee ETF’s are usually “Vanguard” ETF’s. The other thing to beware of are fund of funds, by this I mean the ETF is only comprised of another ETF — which you will then have the ETF charge the ETF fees which will charge you fees, so I would suggest avoiding that.

What are Stocks?
Stocks are ownership in a company. There are two types of stocks — preferred and common, both with advantages and disadvantages. Common stocks usually have voting rights within the company which you can exercise whenever given the option, they could also receive dividends but the dividends are not guaranteed. Preferred shares are typically more expensive, and have no voting rights. So why would you ever buy preferred shares? Well, because they could have a whole bunch of, what I will refer to as “add-ons”, which could include cumulative dividends — this means that your dividends are guaranteed and locked in, if the company can’t pay it right away the money owed will accumulate until they can pay it out. Another good thing about preferred shares is that when dividends get paid out they are the first to get them. There are a list of other “add-ons” that could be present in preferred shares but I will not get into them for this post. The stocks are usually traded on the secondary markets, which are listed above under “What is “The Market”?”, this means that the company does not receive the money you just spent on those shares. The only time the company receives money for the shares they are selling is when they initially IPO which stands for Initial Public Offering (there are a couple other scenario’s but I will not get into them in this post). Where does your money go? Well it eventually goes to another human being selling the shares — so if you made some money it is possible the other person lost money or lost the opportunity to make more.

Recommendation

I would personally recommend investing in individual stocks over ETF’s but only once you feel comfortable enough to be able to chose them confidentiality. If you are just starting, or maybe not confident enough yet to chose individual stocks, or have a sum of money that is relatively small — low cost ETF’s are the way to go hands down; and remember NEVER put your money into 99% of mutual funds.

So that is my take on a really quick post to sum up investing. Let me know what you think, what to add, or what to take away — also let me know if you want to read more about my investing experience, I would be glad to share. In addition, I will make a post about my views on budgeting and saving money in the week to come, so watch out for that if you find yourself interested.

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