To add to the investment knowledge from stocks, let us discuss funds this time.
When you have put enough distance between yourself and your next paycheque with your savings and are ready to invest, you will notice that stocks and bonds can be quite complex to understand and pick. Stocks can be very rewarding if you know what you are doing but what if you just don't have the time to invest in the education to invest in each company. Well, financial institutions came up with a bunch of solutions based on the basics of funds which we will discuss in this post.
Let me explain
To explain this funds simply, let us use an analogy that we(young adults) deal with constantly, your friend's birthday present.
You know how when your friend's birthday is coming and someone in the crew comes up with the fancy idea to get our friend that gift(s) they've always wanted.
If you are that 'someone', my birthday is coming. Remember me in your kingdom.
Let's say we(the friends) come together to upgrade our friend from the dark ages, a blackberry to an iPhone.
By the way, if you are still using BBM in 2017, we can't be friends #justsaying.
Anyways, we know apple will only sell ONE iPhone, not half a phone, or pieces of the phone to all of us individually. So instead, we all pitch in to whomever organized this idea. The special someone now has money to buy it completely from the store and we all get the benefit of having and presenting this one gift as a squad. #squadgoals
As a result of this, our friend thanks us as a whole for this and we all share the new depth of our friendship.
You better buy me an iPhone when it's my turn, my money was not cheap to get please.
So, in the case of a financial institution and investing.
The iPhone would be a huge bunch of expensive stocks that we may not be able to afford individually. We the clients, would be the friends pitching in since we really cannot buy as much stocks individually compared to coming together to buy it as a unit. The financial institution we pitched to will now have the financial muscle to buy a HUGE amount of stocks with our money. When they do this, they distribute the growth in the overall stocks to us based on how much we put in.
Say I put in $200 into a fund and the entire fund is worth $1 million. If the entire fund doubles to $2 million in a few years, my $200 will be worth $400 as a result of the growth of the fund.
That is basically what a fund is and how it works.
There are a few categories of investment funds:
- Mutual Funds
- Index Funds
- Exchange Traded Funds (ETFs)
- Hedge Fund
Mutual Funds
This is the most popular fund that most people will be guided towards. This works as described, we all mutually benefit from contributing towards the fund. The stocks within the fund are usually bought and sold pretty often by the fund manager. The fund manager does this to attempt to beat the market(I explained what 'the market' is here). As a result the fees are higher for mutual funds; they beat the market sometimes, but other times they underperform as well.
Index Funds
These kind of funds are structured differently from mutual funds. The purpose of these is to mirror the market instead of trying to beat the market. As a result of the style of this strategy, there is less management of the stocks within the fund. The fees are cheaper to buy the fund due to less activity and people managing the fund so that is an added bonus. There is also a lot more diversification since you get the entire market as opposed to maybe 20 - 50 in a mutual fund. However, you're following the market all the way up and all the way down when it tumbles. There is no manager trying to avoid an obvious market crash or join potentially the next great stock.
Exchange Traded Funds (ETFs)
These funds are different from both index and mutual funds in the way they are traded. They are traded like stocks and bonds. The prices of ETFs adjust throughout the day based on the stocks within it. Index funds and mutual funds are priced once at the end of the day when markets close. They are structured like index funds to mirror the market with low fees.
Hedge Funds
These funds are generally structured like mutual fund BUT are unregulated by federal securities commissions in the country the fund is setup. Hedge funds usually have a very high buy in and are restricted to high net worth individuals(when you get there) or corporations. They may also use borrowed money to invest so a lot of calculated risk is involved with these funds.
Got it?
If you have more questions, read more in your spare time or ask me.
Other Notes
Financial institutions are not your friend, they do not set up funds for free. There is a charge for them to buy and pick stocks that go in the fund. They also need to hire and pay someone to manage these funds. Please keep an eye on these fees when you pick a fund to invest in.
Remember, we cannot buy half a unit of stock. With a fund, you technically can. If you had only $100 to invest but you wanted to reap rewards of investing in a company like Apple, you could buy a fund that has that stock within it. The institution would give you however much of the fund that $100 is worth at the time of purchase and you are now going to enjoy all the benefits others in that fund are reaping.
You can schedule your "pitch in" with your funds. So if you get paid bi-weekly, you could
Also, when the funds are set up the fund will not only buy one company's stock. The fund will buy a whole bunch of companies in that sector. After this, the fund will also buy a whole bunch of sectors based on the strategy of that fund. The strategy of exposing your portfolio(a fancy term for your total financial snapshot) to a wide range of stocks is called diversification.
Goodluck Investing!
