May 23, 2016


A simplistic definition of an investment is the purchase of an asset, tangible or otherwise, with the expectation that a return will be generated in the future without sacrificing the initial principal.

Stock or Equity Investment

When most people think of investing, stocks and equities are the first investment vehicle to come to mind. An investment in a stock or equity is the action of purchasing ownership of a company or corporation. The purchase of stock allows the owner of the underlying stock to participate in the growth and decline of the entity.

There are two types of stock classes, and each has benefits and disadvantages. The first type of stock class is known as common stock. Common stock represents ownership in an entity; owners are given voting rights to vote on directors and other major decisions that the entity faces. Typically, the owner of common stock receives one vote per share, and the owner can vote either in person or by proxy at the company’s annual shareholder meeting. Common shareholders, in addition to voting rights, have the right to receive dividends. Dividends are a distribution of profits, usually distributed quarterly, to the shareholders of the company.

The second type of stock class is known as preferred stock. Preferred stock represents ownership in an entity, like common stock. However, preferred stock does not grant voting rights like those of common shareholders. Preferred shareholders typically receive fixed dividends that do not fluctuate, and they enjoy priority of assets in the event that the entity claims bankruptcy.


Corporations, private companies, the U.S. Treasury, municipalities, and other U.S. agencies will issue bonds to raise capital for growth, expansion, and other needs, such as maintenance. Bonds do not represent ownership in the issuing entity. Bondholders purchase a bond at a par value, and the bond will provide interest, known as a coupon, to the bondholder, plus the return of principal. The price of the bond will fluctuate over the life of the bond.

There is an inverse relationship between a bond’s price and yield. As the bond price goes up, the yield goes down. Conversely, as the price of a bond is reduced, the yield goes up. The fluctuation in price is due to risk. If the issuing entity becomes unstable, the price of the issued bond will be lower to entice buyers to purchase the bond. As the buyer assumes more risk, he/she require a higher yield or rate of return for taking on more risk.

Exchange-Traded Funds (ETFs)

Exchange-traded funds (ETFs) can be actively or passively managed. Actively managed ETFs attempt to outperform the index or basket of assets that the fund benchmarks. A passively managed fund mirrors the index that it tracks. ETFs trade like common stock and can be purchased and sold like stock. Like with common stock, the owner of the ETF is entitled to dividend payment. Some of the more popular ETFs are State Street’s SPY 388,08 +8,70 +2,29%, Invesco PowerShares’ QQQ 268,80 +7,22 +2,76%, and State Street’s DIA 336,28 +7,06 +2,14%.

ETFs carry a small expense fee for the management of the ETF, which is typically lower than the cost of other managed investment vehicles, like mutual funds. The cost basis of an ETF dates back to when the investor purchased the ETF. Unlike with a mutual fund, capital gains taxes are applicable to the investor when he/she purchases the ETF and not when the fund sells its holdings and triggers a capital gain. This is a distinguishing characteristic of an ETF. The investor is not responsible for the capital gains dating back to the fund’s inception but only to when the investor purchased the ETF.

Mutual Funds

Mutual funds, like ETFs, can be actively or passively managed. Mutual funds pool money from multiple investors to purchase larger and more diversified holdings than any one investor can purchase on their own. It gives the small investor access to professional money management that may not otherwise be available to them. These investment vehicles are managed by a management team called money managers. Mutual funds have expense fees that pay the management team and pay for marketing materials and other daily expenses. They are required to be disclosed in a prospectus.

Mutual funds come in several classes: A shares typically charge a front-end sales charge. B shares do not charge a front-end sales charge but have a higher annual expense, which may affect the overall return on investment. Overtime, Class B shares will convert to Class A shares, which have an overall lower annual expense fee. Class C shares, like Class B shares, also do not have an up-front sales fee but will not convert to Class A shares. This means, overtime, Class C shares will be more expensive than Class B shares. Additionally, Class C shares may impose a small charge if you sell them within a defined short time, usually during the first year. It is important to read each fund’s prospectus before you decide which class of shares you purchase.

Mutual funds can be open or closed; closed funds are not open to new investment dollars from new investors. As mutual fund assets become larger, it can be harder for the management team to invest in stocks, bonds, and other investment vehicles without affecting the market. Large purchases and sales of mutual funds can adversely impact the stocks or bonds that a money manager invests in by “moving the market” and driving the price of the stock or bond up or down solely based on the money manager’s actions.

The value of a mutual fund is calculated once per day, which is called the net asset value, or NAV. Since the value of the mutual fund is only calculated once per day, the investment isn’t as liquid as an ETF; an ETF can be sold like a common stock. When a money manager sells individual stock positions for a capital gain, the mutual fund must pass those gains on to the shareholders. The capital gains track back to the inception of the fund and do not correlate to when an investor purchased the mutual fund.

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