In this post, you will understand the different investment options available for people just starting out and those looking to build wealth through the stock market.
Things to consider when choosing an investment
Your decisions should be based on a variety of factors, most notably, how soon you would need your money and your risk tolerance.
How long are you willing to put your money to work?
– Short-term (5 years or less)
You could be investing for a home, car, education or your wedding ceremony. If this is the case, you are most likely going for investment options that would allow you to preserve your savings, and see some modest gains and income.
– Long term (beyond 10 years)
Can you leave your money alone to grow and compound? This kind of investing is like watching clubs in the Nigerian football league play – very boring.
You are like Warren Buffett: you want to buy shares in companies that you know have sound management, a clear advantage over competitors and would still be around creating value 10 — 20 years from now.
How well do you sleep at night when your investment’s losing money? Can you stay optimistic during a deep recession?
Knowing your risk tolerance is important because investing is more of an emotional game than an analytics game. Your behaviour and how you react to money gets to determine your investment returns a lot of time. So, you’ve got to know your investing self.
How do you know your risk tolerance level?
A simple way to know is by taking a small amount of money, invest in a volatile asset (like the stocks of a small company on the stock market) and see how you react when you lose money. The knowledge you get from that experiment could save you from far worse emotional turmoil in the future.
1. Individual stocks
Stock is ownership in a company. Stock is sold in units called shares. A person that owns stock is called a shareholder or stockholder. The performance of your investment depends on how the company performs over time and what others think about that performance.
Example: If you buy shares of Netflix because you believe they are a great company, the profitability of your investment would depend on the success of Netflix’s business model over time.
There’s no limit to the number of individual company stocks you can own. However, picking stocks could be such an extreme sport. How do you know which company to buy?
2. Exchange-Traded Funds (ETFs)
If stocks were fruits, this would be an investor’s smoothie – a blend of different investments that an investor can easily buy. Some investors prefer to own stocks in exactly one company. Others prefer owning the whole industry. Investors who prefer the latter would buy an ETF. It provides the opportunity to invest in a whole sector without having to pick any single company in it.
Like a smoothie, there are different flavours of ETF: it can be a certain industry (retail or consumer services), a certain region (China or Frontier/Emerging market stocks), or certain market (buy the whole of the US market or the Chinese market). These ETFs are designed by professional portfolio managers with experience studying the market.
Instead of buying Netflix, Apple, Facebook and other companies’ shares separately, you could get all in one basket with ETFs. It gives you the ability to spread out your risk and still build wealth.
Example of an ETF is: Vanguard S&P 500 Growth ETF, which tracks some of the biggest growth companies on the S & P 500 including Microsoft, Amazon, Facebook, Alphabet and others.
3. Mutual funds
ETFs and mutual funds are quite similar as they both represent professionally managed baskets of individual stocks.
With mutual funds, you’re pooling together your funds with other investors and giving it to a professional fund manager to help you invest it. It saves you from the time and effort involved with picking individual stocks.
The major differences between ETFs and mutual fund are: mutual funds managers are not obligated to disclose the companies they invest in unlike an ETF, and mutual funds don’t allow you to use more sophisticated order types that give you control over your buying and selling price.
Also, mutual funds are actively managed, which means your returns are based on the investing skills of your fund manager.
Remember, consider how long you are willing to put your money to work and your temperament. Most investors pick individual stocks when investing for the long term, ETFs are used to reduce risk while mutual funds are suitable for investors willing to trust a fund manager’s skill and pay for investing on their behalf. You could also use a combination of the three options.