Investments That Pay Their Way

There are many different types of investments that can pay off, and they can be broadly categorised into three types: ownership, lending, and cash equivalents. Ownership investments include stocks, real estate, and precious metals. The aim is for these investments to increase in value over time, and they can be further broken down into traded securities, such as futures and currency swaps, and physical commodities, like gold bars. Lending investments include bonds and savings accounts, which are loans that earn interest over time. Cash equivalents, such as money market accounts, are low-risk and can be easily liquidated when needed.

Stocks or equities

Stocks, shares, and equities are terms used to describe units of ownership in one or more companies. The owner of these units is known as a shareholder. While these terms are often used interchangeably, there are some technical differences.

Stocks

"Stocks" generally refers to portions of ownership of multiple companies. For example, you could say that you own stock in Amazon and Microsoft. Stocks are bought and sold predominantly on stock exchanges such as the Nasdaq or the New York Stock Exchange (NYSE).

Shares

"Shares" usually refer to units of ownership in a specific company. For example, you could say that you own ten Amazon shares. Shares are traded on large public exchanges and sometimes in private offerings.

Equities

"Equity" is the term for a total ownership stake in the company. For example, if a company had 10,000 shares, and you owned 1,000 of them, you could say that you held a 10% equity stake in that company. Equity includes stocks as well as other tangible assets excluding debt.

Stocks vs. Equities

All stock involves equity, but not all equity is stock. Equity exists in any business venture where value can be split among owners, including big business corporations and smaller company setups such as sole proprietorships and partnerships. However, not all equity ventures have stocks. Stocks are generally seen in companies and not in other forms of business structures.

Benefits of Investing in Stocks

• Historically, stocks have outperformed most other investments over the long run.
• Stocks give you an equity stake in a company and are viewed as one of the best ways of potentially making long-term capital gains in the financial markets.
• You can share in a company's tangible profits while not being personally liable if anything untoward happens to the company.
• A portfolio of stocks rarely requires day-to-day management, allowing investors to participate in the stock markets without investing too much time.

Risks of Investing in Stocks

• The biggest downside of investing in stocks is having to undergo bear markets and periods when the stock market is turbulent. The value of the market goes down during these times, and it's possible to lose a significant amount of wealth that can take several years to recover.
• Stocks are considered a higher-risk investment than fixed-income investments like bonds or guaranteed investment certificates (GICs).

Bonds or fixed-income securities

Fixed-income securities are those that pay investors a fixed interest or dividend payment until they mature. They are considered to have lower returns and lower risk than stocks. The most common types of fixed-income products are government and corporate bonds.

Fixed-income securities are recommended for conservative investors seeking a diversified portfolio. They can be purchased directly, or investors can choose from a variety of fixed-income exchange-traded funds (ETFs) and mutual funds.

• Treasury bills (T-bills) are short-term debt instruments issued by federal governments. They are highly liquid and considered very secure.
• Banker's acceptances (BAs) are short-term promissory notes issued by corporations, guaranteed by a major chartered bank.
• Treasury Inflation-Protected Securities (TIPS) are bonds that protect investors from inflation by adjusting the principal amount with inflation and deflation.
• Municipal bonds are similar to treasury bills but are issued and backed by a state, municipality, or county. They can offer tax-free benefits to investors.
• Corporate bonds come in various types, with the price and interest rate depending on the company's financial stability and creditworthiness.

Fixed-income securities offer investors a steady stream of income and help stabilize the risk-return in their investment portfolio. They are generally considered a conservative investment strategy, providing predictable returns from low-risk securities.

Index funds or mutual funds

Index funds and mutual funds are both popular investment options for those looking to diversify their portfolios. They are similar in that they both allow investors to spread their investments across various assets and industries, decreasing their level of risk. However, there are some key differences between the two.

Management Style

Index funds are passively managed, meaning they aim to replicate the performance of a market index like the S&P 500 or the Dow Jones Industrial Average. They are designed to be a simple, no-fuss way to gain exposure to a broad, diversified portfolio at a low cost. Index funds are often considered a more "passive" investment strategy, as they do not require active management or stock-picking.

On the other hand, mutual funds are typically actively managed, meaning they have a team of professionals who actively select the investments for the fund with the goal of outperforming a stock market benchmark. Mutual funds are considered a more active investment strategy and usually come with higher fees than index funds.

Investment Objective

The primary objective of index funds is to mirror the performance of the underlying benchmark index as closely as possible. Index funds are designed to provide broad market exposure and diversification across various sectors and asset classes.

Mutual funds, on the other hand, aim to outperform market averages and provide higher returns by having experts strategically pick investments. Mutual funds are often considered a more aggressive investment strategy, as they aim to beat the market rather than simply replicate its performance.

Cost

Index funds typically have lower fees and expense ratios than mutual funds. This is because index funds are passively managed and do not require a large staff of investment professionals. As a result, they are considered a more cost-effective investment option.

Mutual funds, due to their active management and higher operating costs, tend to have higher fees and expense ratios. These higher fees can cut into the returns that investors receive, potentially leading to underperformance compared to index funds.

Performance

Over the long term, index funds have often outperformed actively managed mutual funds, especially after accounting for fees and expenses. This is because it is difficult for mutual funds to consistently outperform the market, and the higher fees they charge can eat into their returns.

However, there are some fund managers who are able to beat the market, especially in the short term or during specific market conditions. Mutual funds may be a good option for investors who are willing to take on the additional risk and cost in exchange for the potential of higher returns.

Suitability

Index funds are generally considered a good option for long-term, passive investors who are looking for a simple, low-cost way to gain exposure to a diversified portfolio. They are also a popular choice for beginners as they are easy to understand and provide instant diversification.

Mutual funds, on the other hand, are better suited for investors who are willing to take on more risk and pay higher fees in exchange for the potential of higher returns. Mutual funds may be a good option for those who want more active management of their investments and the potential to outperform the market.

Real estate

Diversification and Protection

Tax Breaks and Deductions

Build Equity and Wealth

As investors pay down a property mortgage, they build equity, increasing their net worth. Equity can be leveraged to buy more properties, leading to increased cash flow and wealth.

Competitive Risk-Adjusted Returns

Leverage

Passive Income

High Return Potential

While real estate offers these advantages, it's important to consider potential drawbacks, such as illiquidity, high upfront costs, and the time-consuming nature of managing physical properties.

Commodities

• Physical ownership: This is the most basic way to invest in commodities. Precious metals like gold and silver are popular for this type of investment as they are small, transportable assets. However, it can be impractical for larger commodities like bales of cotton or barrels of frozen orange juice.
• Futures contracts: Futures contracts are a prominent and well-known method for investing in commodities. They are a legal agreement to buy or sell a particular commodity at a predetermined price and date in the future. They offer high leverage, allowing investors to control full-size contracts with a minimum deposit account. However, they are also risky, as small price moves in commodities can result in large returns or considerable losses.
• Individual securities: Shares of companies that produce or are otherwise involved in the commodity grant indirect access to the market. For example, if the price of oil rises, companies producing oil may experience increased revenues and profits.
• Mutual funds, exchange-traded funds (ETFs), and exchange-traded notes (ETNs): These funds can provide wide exposure to commodities with relatively low investment minimums. They can be specific to a particular commodity or cover a broader array. While they require no special brokerage account, they may not always accurately reflect the underlying commodity's price.
• Alternative investments: Hedge funds or private investments specializing in commodities are highly speculative and leveraged, carrying a high degree of risk and volatility.

Frequently asked questions