So now that you know what investor personality you have, the next step is to decide which investment vehicles are suitable for your investing type of personality. There is a vast array of investment strategies and methods out there and just so you know, there is no one correct way to go about investing. Each strategy has its virtues and have aspects that may only be suitable for certain investors. Your goal is to be knowledgeable enough to comprehend and analyze before deciding which investing strategy fits your investing style.
Bonds are loans made to governments or corporations, where the borrowing party agrees to pay the bond back at a promised date. Until then, the borrower makes agreed-upon interest payments to the lender, also known as the bondholder. That is why bonds are also known as fixed-income securities, securities that are founded on debt. The lender receives income in the form of interest payments and if the lender holds the bond to maturity, he/she can get all his principal back. This is what makes a bond so safe. If you are purchasing a Treasury bond (T-bond) from the US government for example, your investment is virtually risk-free as you don’t have to worry about the US government defaulting on its debt. While bonds offer safety and stability, it is not without its cons. Because there is little to no risk, there is little potential return. As a result, the rate of return of bonds are often generally lower than other securities. If you find that your investment in bonds may not earn you enough to beat inflation, it is time to diversify.
Should your bond offers you a highly attractive interest rate, you should be dubious about the corporation offering it. Companies can also default on bonds, offering highly attractive interests knowing that they may not be able to pay up. The highest paying and highest risks ones are often called junk bonds.
Equities or stocks of a corporation typically represent an ownership in the company. It denotes the real value of one’s stake in an investment as investors who purchase stock in a company are usually only interested in their own personal equity in that company. This personal equity is represented by the amount of shares they own. Owning shares in a company should ideally yield capital gains for the shareholder over time, as well as receive potential dividend gains.
Although both bonds and stocks allows investors to receive income through interest and dividend payments, the risks each carries are different. Bonds are often deemed as stable and safe, while stocks on the other hand are volatile. They fluctuate on a daily basis depending on the demand of each investor and the economy outlook. Unlike bonds, there is no guarantee when purchasing a stock. Profits and losses are often considered unrealized on paper until you decide to sell them to realize those profits or loss. Many stocks may or may not pay dividends and if they don’t, the only way for the investor to profit from it is to wait for the share price to increase in value. This capital appreciation may or may not even happen. That is why while stocks may offer a higher potential return, they carry a higher risk where investors need to determine if they are able to accept that. (Read here to find out what is your investor personality type.)
Don’t worry if you are undecided between investing in bonds or stocks as your investment does not have to be mutually exclusive. We know that diversification is needed to maintain a well-balanced portfolio, isn’t it? Of course, there is then the mutual funds which is a professionally managed investment fund that pools money from many investors to purchase a collection of stocks, bonds or other securities that might be too difficult to do it on your own. The price of the mutual fund is usually determined by the total value of the portfolio, divided by the number of the fund’s outstanding shares. A mutual fund encompasses both the likes of bonds and stocks by allowing an investor to receive income in the form of both interest and dividend payments. In addition, if this fund has securities that have increased in price, the value of the mutual fund rises and yields greater capital gains for investors over time.
If you find that you do not have the time or expertise to manage your portfolio, you may want to consider purchasing mutual funds instead. It is not only a more inexpensive way to own a diversified portfolio, there is also professional management of your mutual fund. Of course, mutual funds is not without its shortcomings. By allowing the “professionals” to handle the funds means there could be a risk of adverse selection especially when these “professionals” make decisions based on asymmetrical information and their risk appetite instead.
Other investments: REITs, Forex, Commodities, Options, Futures etc.
Then of course, we have many other more complicated investing vehicles such as real estate investment trust, forex, commodities, options and futures, just to name a few. These are securities that can generate higher potential returns but they come with higher risks that are much more speculative in nature. We will try to cover more in-depth explanation in future writings, but as of now, you do not have to worry about having to understand these complicated investments. There is nothing shameful about starting with just the usual stocks and bonds. If you don’t understand, go in-depth, gain more knowledge, build your own financial foundation – You might just get better at it even if it is plain old stocks and bonds.