Once you’ve
created and funded a brokerage account, you’ll be able to purchase your first
investments. This is where things can get a little complicated, because there
are more than a few asset classes to consider.
Individual
stocks: When you invest in stocks, you are buying shares of ownership in
individual companies. Buying individual stocks can be risky, because your
potential for loss will be greater unless you make sure to diversify your
portfolio. On the other hand, stocks also possess great potential rewards; if the
company does well, your shares could soar in value.
You can
lessen this risk of investing in stocks and increase your total return by
spreading out your investments over a variety of stocks, across different
industry sectors, such as basic materials, financials, health care, consumer
goods, technology and utilities.
Mutual
funds: A mutual fund is a professionally
managed investment vehicle that pools investor money to purchase securities,
such as stocks and bonds. Mutual funds are popular with investors because they
can provide asset diversification with a small upfront investment.
For example,
if you have $1,000 to invest, it probably makes more sense to purchase $1,000
worth of shares in a diversified mutual fund than to buy $100 worth of shares
in 10 different stocks. Tracking and following 10 different stocks can also be
very time-consuming, making mutual funds an even more attractive choice for
beginners and passive investors.
To choose a
quality mutual fund, you should carefully compare the expense ratios of each
fund, evaluate the fund’s investment objectives and past performance, measures
the fund’s potential risks and returns, and go with a fund that is run by a
high-quality management team.
Exchange-Traded
Fund (ETF): An ETF is a fund that generally tracks an index, which can be
traded on an exchange, exactly like stocks. ETFs generally don’t try to
outperform a fund or an index; instead, they aim to match its performance. For
example, if you wanted exposure to the U.S. stock market, you could buy an ETF
that tracks the performance of the Dow Jones Industrial Average or the Standard
& Poor’s 500.
ETFs can be
an attractive option over actively managed mutual funds because they tend to
offer lower administrative costs. The average expense ratio of an ETF is 0.43%,
compared to an average of 1.4% for traditional mutual funds, according to ETF
Database. On a $10,000 investment, you’d forfeit $43 in fees with the ETF,
compared to $140 with the mutual fund.
