Updated: Dec 16, 2020
BY SOPHIA REBOLLEDO
Teens often feel like there is a disconnect between them and the world of business and investing as its complexity may be intimidating. This article will provide insight on the basics of investing terms covering stocks, mutual funds, bonds, ETFs, and interest.
Stocks are the most volatile investing vehicles as they are the riskiest but may return higher profits. Over the long term, stocks have a higher return than bonds or savings accounts. But this volatility means that over the short term, other types of investments may significantly outperform stocks. When selecting the best stocks, some things to keep in mind to gain most return back are a stock’s current market price compared with an estimate of the stock’s fair value, the uncertainty adjustment, the economic moat, events in the world, and many more.
Another investing vehicle are mutual funds. Mutual Funds are perfect for investors who do not want to manage your own investing money as your money is pooled with other investors money to create a balanced portfolio (it is still important to choose the right mutual fund for your financial goals.) This portfolio is managed by a group of professionals who try to earn a return by selecting stocks for the pool. Unlike with stocks, mutual funds charge fees for the professionals that manage your portfolio and these fees eat into returns. In addition, the more money you have invested in mutual funds, the larger the absolute value of fees you will pay every year.
Bonds are very similar to loans. When you purchase a bond, essentially, you become a lender to an institution or company. This institution or company will then pay you back interest and the principal on the bond. There are two main types of bonds: government bonds and corporate bonds. In the U.S., government bonds are issued and guaranteed by the government to fund public projects. These types of bonds offer a modest return with low risk as it is highly unlikely for the government to crash. Corporate bonds are issued by companies and carry a higher degree of risk as well as return. In addition, investors should consider interest rate risk. The only way to ease interest rate risk is to hold the bond to maturity. It is important to research the bonds you invest in but given their lower risk, their relative safety comes with lower returns compared with stocks over the long term.
Exchange-traded funds (ETFs) have aspects of mutual funds and stocks. Similar to mutual funds, ETFs are baskets of securities, but can be bought and sold (short-selling also) throughout the trading day on a margin. Similar to stocks, ETFs trade on an exchange. Anything you might do with a stock, you can do with an ETF. There are numerous equity ETFs on the market, including MidCap SPDRs, DIAMONDS, SPDRs, and Select Sector SPDRs. While conventional mutual funds outnumber ETFs, funds drill down into specific sectors, industries, regions, countries, and asset classes which make up a greater percentage of the ETF world, offering inexpensive access to investments such as currencies, precious metals, and many more that have been the sole province of larger institutional and wealthy investors.
There are two types of interests simple and compound interest. Simple interest is the amount of interest earned on the original amount of money invested. Compound interest is interest paid on interest as well as principal. With interests, the longer you invest your money, the higher your interest payments will be (time is money!). The interest resulted each year will be based on not only your initial investment but also the previous interest that has accumulated, which is what makes compounding interest so powerful!