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Investment 101 – Understanding Investment Types

Published December 09, 2021

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Financial Planning
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As your medical career begins to take off and you have more resources to invest, you’re probably starting to do some research on which investments make sense for you. As you dig in a little deeper, it’s very likely that you have more questions than answers.

You’re not alone. Investing is complex and complicated. But rest assured, we’re here to help you better understand the options available to you.

There are a myriad of investments you might look into, including real estate, private equity, venture capital, private credit, structured notes and hedge funds, among others. For our discussion, we will focus on three of the most common investments: stocks, bonds and mutual funds.

Stocks

When you buy a stock, you are buying a share of ownership in a company. Over a long period of time, the value of your stock will be driven largely by the earnings and dividends of that business.

Over the short term, the price of your stock may fluctuate based on a variety of factors including, geopolitical events, monetary and/or fiscal policy, changes in the competitive landscape, and the risk appetite of the market.

As companies grow, they may choose to return some of their profits back to you, the investor. They can do this one of two ways. First, they can issue a dividend, which is distributed on a per-share basis and is typically paid quarterly.

A second way companies can return profits is through share buy-backs. Buy-backs make the shares of that company more valuable, as there are fewer shares to divide into the overall value of the company. Just as companies can buy back shares, they can also issue new shares to raise capital. This can potentially reduce the value of existing shares in the short term. However, if the company invests that capital successfully, it could increase your earnings and the value of your shares in the long run.

Bonds

When you buy a bond, you are essentially lending money to the issuer. Bonds are issued by companies, governments, government agencies, state and local municipalities, universities, and others.

Issuing bonds is one method these entities use to raise capital. Your local utility company, for example, may be looking to build a new power plant and will issue bonds to raise the needed money.

The same is true for governments. Your local municipality may be looking to build a new road or perhaps a new stadium, and can issue bonds to pay for that expense.

Like a car loan, a bond traditionally has an interest rate and a term. For example, company XYZ will pay a 4% rate for five years. The investor will receive 4% per year, typically paid semi-annually, then a maturity payment at the end of year five.

A bond may become less valuable or more valuable, regardless of the strength of the issuing entity. Let’s say a bond is paying a 5% return. When market rates for similar investments are low, say 3%, that bond paying 5% becomes more valuable to investors who may be willing to pay more for it on the secondary market.

The inverse is also true. If similar investments are paying 7%, the bond’s resale value may be considerably lower than its stated value. No matter the direction of interest rates, as a bond gets closer to its maturity date, the price gets closer to face value. So if you own a bond until maturity, you’ll know exactly what the return will be.

Mutual Funds

When you buy a share of a stock or a bond, you’re buying a single investment. With mutual funds, you’re investing in a portfolio. These investments are usually comprised of stocks and bonds and may also include mutual funds, real estate, commodities, or pretty much anything you can imagine.

A mutual fund will have a stated objective that defines what will be purchased by the fund. Mutual fund investment objectives may be simple or they may be incredibly complicated and unique, like a mutual fund which invests in environmentally responsible companies in Brazil.

Management fees are part of the overall expense of a mutual fund, which is something you should consider when comparing various funds.

In Summary

Stocks, bonds and mutual funds are just the tip of the iceberg when it comes to the universe of investment options. There are also exchange traded funds, hedge funds, private equity, real estate, precious metals, private credit, structured notes, and more. While each has its own set of potential returns and risks, it’s the relationship between them that allows you to build a customized, well-diversified portfolio.

When creating your own portfolio, consider the following:

  • Think about your risk tolerance and time horizon for each investment before deciding which is the best fit.
  • Take advantage of the tax-preferred treatment of the different retirement and education account types.
  • When evaluating stocks, bonds and mutual funds, remember that rate equals risk and be aware of the underlying costs of mutual funds.

 

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