I wish the answer to that question was easy enough to answer in a simple blog post. 😉 Unfortunately it is not which brings me to today’s topic, the different ways to invest.
After you figure out what your goals are for starting to invest, you must decide on a plan for your investments. It doesn’t matter how hard you fight lifestyle inflation and save up if you just go out and blow all of your money on penny stocks on day one.
So what investing strategy is the best for you? This all depends on your risk tolerance and willingness to dedicate time to researching your options. The ones I would like to highlight today are: index funds, mutual funds (managed funds), exchange-traded funds, individual stocks, and dividend growth investing. Note: this blog post is only going to cover some of the basic forms of stock market investing. This may be a little too simple of an explanation for some but I’m designing this as sort of a broad introduction for many more blog posts in the future where I’ll go into more detail.
Index funds are by far the easiest investing strategy to implement. An index fund is a mutual fund that buys all the companies in a certain market index. The S&P 500 is a popular index which is made up of 500 of the largest companies in the U.S. You’ve probably heard of quite a few of them: Coca-Cola, Boeing, Exxon Mobil, Kellogg Co., Johnson & Johnson, and Google are all in the S&P 500. The index has returned around 9% annually over its lifetime. That doesn’t mean your money will grow by that much each and every year. Some years you’ll be up by 20%, others down 20%, but in the long-term, your returns will average out to about 9%. Another great thing about index fund investing is the low fees. Index funds have some of the lowest expense ratios in the industry. Not paying 2-3% in fees each year will really help boost your returns over your investing life. If you are interested in index funds, I’d recommend looking at Vanguard’s funds and for my fellow federal employees, the “C” Fund in the Thrift Savings Plan.
Managed mutual funds come in all sorts of different categories. Large cap funds, small cap funds, international fund, growth funds, income funds, growth and income funds, and value funds just to name a few. These funds are actively managed by a fund manager unlike an index fund which just duplicates the holding of the index. This can have pros and cons. If you have find a fund with a very good manager, you have a chance of beating the market or beating the index. On the other hand, these usually have a lot larger fees than index funds which can diminish your returns over the long-run. Also most actively managed mutual funds fail to beat the major market indices like the S&P 500.
Exchange-traded funds or ETF’s are basically mutual funds whose shares are traded like shares of stock on the open market. With a normal mutual fund, you buy more shares and invest directly with the mutual fund company like American Fund, Prudential, or Vanguard. With an ETF you must have a brokerage account and then you can simply make orders for the ETF like a stock. Just like mutual funds, the different types of ETF’s are endless. Some of the more popular ETF’s are those that track various indices, so if you’re into index investing, this is another choice for you. Regular brokerage commission charges will still apply to you in addition to the fund’s expense fees.
Next up in investing in individual stocks. Unlike the previous methods, individual stock investing requires a lot more work for the investor. With the other methods you are essentially paying someone else to make all your buy and sell decisions along with all the associated stock research for you. With individual stocks, it all falls on you. To invest in individual stocks you must be willing to put in the time to do the proper homework before you buy/sell a stock.
Within the individual stock investing world there are several different types of strategies, similar to mutual funds. These include investing in growth stocks-fast growing companies aggressively expanding (think Google when it first launched) and investing in dividend paying companies-more mature companies that often return a large amount of their earnings to their shareholders in the form of dividends such as General Mills (GIS). Although you can grow your portfolio a lot faster by investing in the right growth stocks, you are much more susceptible to the volatility of the market. Once Wall Street sees growth slowing at one of these companies, their stock prices usually suffer a lot for it. Therefore, you have to make sure you putting in a lot of research when using this strategy. The latter method is my preferred way to invest in individual stocks. In particular, I prefer dividend growth stocks, companies that not only pay out dividends but also consistently raise them each year.
This allows me to build up a portfolio that produces an ever-rising stream of income for me to use. For right now I’m just reinvesting my dividends back into my portfolios to better compound my returns. Once I reach financial independence I’ll use this dividend income to pay for my living expenses.
In conclusion, there are many different ways to invest in the stock market. To best determine which one is right for you, you should conduct additional research into each of the above strategies. Also you aren’t limited to just one strategy, although I’m primarily a dividend growth investor myself, I also invest in index funds through my employer’s retirement plan. The important part is to find a strategy that works best for you, make a plan to use that strategy, and stick to it. Good luck! 🙂
Full Disclosure: I am long Coca-Cola (KO) stock. What investing strategies do you use for investing in the stock market? Do you any of you use ones different from the ones I mentioned today? Please leave a comment and continue the conversation.