Lesson two: stocks and bonds
The stock market is very volatile. There are big increases (known as “bull market”) and big decreases (known as “bear market”). In movies and television, investing in the stock market is often portrayed as this risky thing where some guy is smoking a cigar and figuring out which “hot stock” to pick.
Investing in the stock market just feels too risky. I don’t want to lose all my money! Plus, I was just plain confused about how to go about investing.
Investing in the stock market feels daunting. Everyone is always saying to invest, but they never say what to invest in.
I would hear about the “S&P 500”, how do I invest in that? Is that all I need to invest in? My friend’s dad’s uncle said to invest in Tesla. Or should I invest in Amazon? Or tech stocks? Everyone’s talking about artificial intelligence, are there stocks that track that?!?
Let’s start with the basics: stocks and bonds.
Stocks
Stocks is a share of ownership in a company. You can buy stock in companies that have “gone public” and allowed the general population to buy into the company. Stocks generally provide a higher rate of return on your money, but they are riskier and more volatile.
Bonds
Bonds are a company or government’s debt. When you buy a share of a bond, you are giving a loan to a company or the government. You earn profit on the interest the bond gets, in addition to getting the initial amount back after a certain time period. Bonds are generally less volatile than stocks and provide a lower rate of return on your money.
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It’s common advice to not put all your eggs in one basket. Diversification is key. You don’t want to buy a bunch of stock in just a few companies and then many of them (or worse, all of them) do poorly.
A way to diversify your investments is by buying stock in a whole bunch of companies. That way, if some of the companies fail, you don’t lose all of your investment portfolio’s value. A way to do this is by investing in mutual funds or exchange-traded funds (ETFs).
Mutual fund
An investment that pools money together from many investors and invests it in a variety of assets. Hence the name, mutual fund 🙂
Index fund
This is a type of mutual fund or ETF that holds every stock in a particular financial market index.
You always hear people talk about the “S&P 500”. Well, there are index funds from different brokerages that track the S&P 500.
Vanguard 500 Index Fund ETF (VOO)
Fidelity ZERO Large Cap Index Fund (FNILX)
Exchange-traded funds (ETFs)
Exchange-traded funds are similar to index funds. They both are a way for you to buy all the stocks in a particular index. ETFs differ from index funds in that they are traded throughout the market day
Traded meaning you can buy and sell them throughout the business day. Index funds are only bought and sold once a day, at market close.
Continuing the S&P 500 example. Vanguard 500 Index Fund ETF (VOO) is an ETF that tracks the S&P 500.
Target date index funds
Target date index funds are “all in one” funds that usually consist of three or four funds: a U.S. total market index fund, an international total market index fund, and a U.S. total market bond fund. Sometimes, they also include an international total market bond fund.
They’re a straightforward and simple way to invest. I think of them as something good for people who know they should be investing, but don’t want to manage a bunch of different funds and having to rebalance them every year. (a.k.a. a lot of people).
Beware! There is a difference between target date index funds and target date funds. Target date funds usually have a higher expense ratio. Target date index funds are the ones with the low expense ratio.
Fidelity, a popular brokerage firm many people use to invest, has these two types of funds. They can be easily mixed up. But they are different!
