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When it comes to the stock market, there are different ways in which you can invest and this lesson will break down the most popular avenues.

 


The most popular avenues to invest in the stock market include investing in stocks, bonds and funds. Other avenues include investing for your child's college education and investing for retirement.
 

1. Investing in stocks

Stocks also known as shares, are essentially your ownership stake or equity in a company. When you buy a company’s stock, you are now an owner or shareholder. The value of the stock you buy depends on several factors including the company’s size, what’s happening in the stock market, the company’s potential for short and long term growth and more.

There are two types of stocks you can purchase and they are:

  1. Common stocks 
  2. Preferred stocks
 
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Common stocks

These types of stock are issued by all publicly traded companies (i.e. companies which you can buy their stock in the stock exchange) and when people talk about stocks, common stocks are usually what they are referring to.


As a common stock holder, you’ll reap the benefits of the company’s increased stock value, and any dividend sharing that happens when the company turns a profit. You may even be able to vote to elect the board of directors and even vote on major transactions such as mergers and acquisitions.

 

Preferred stocks

Preferred stock has advantages over common stock in that preferred stock owners have a greater claim to the company’s assets and typically earned a fixed dividend payment regardless of how the company is performing. In addition, if the company goes bankrupt, their greater claim on the company’s assets and earnings, allows them to get paid before common stock holders. However, preferred stock also has its own disadvantages.


For instance, they have very limited or no voting rights, the value of the preferred stock appreciates less because of the fixed dividend amongst other disadvantages that make them less popular.

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In summary, as a holder of common stock you assume more risk but you stand to gain considerably more than preferred stock holders when the company is doing well and growing.

 

Note: Throughout this course, the reference to stocks outside of this preferred stock illustration, is specifically to common stocks.


Why do companies sell stock anyway? 

Companies sell stock to raise capital from investors in order to grow their businesses. You buy their stock and in return they incentivize you by aiming to improve the value of the stock and as an added bonuses, some companies will even pay out dividends.

 

What about market capitalization? How is it related to stocks?

This is something talked about a lot in the financial news. Companies are typically broken into large cap, mid-cap and small cap. Cap stands for capitalization, a.k.a. market cap and it is calculated by multiplying a company’s outstanding shares by the company’s stock price per share. 
 

Large cap companies

These are companies with market caps that are $10 billion or above. They are considered more stable and less risky especially during and after recessions. Examples of large cap companies include Walmart, Apple and Google.
 

Mid cap companies

These are companies with market caps that are between $2 billion and $10 billion. They have high potential for growth and so are deemed more risky.

Small cap companies

These are companies with market caps that are less than $2 billion and are usually young companies. They have very large growth potential and as a result are considered high risk.

 
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2. Investing in bonds

A bond is basically an IOU (I owe you). It is a loan that you as an investor can make to the government, a corporation or an organization to help them raise money and in exchange you’ll receive earnings based on the interest payments they pay you for the money you loaned them over a specified term. The type of bond issued depends on the entity issuing the bond.
 

With bonds, you face the risk of losing money if the entity in question is unable to pay you back in full or if you cash out your bond investment before the bond term agreement expires however, bonds are graded by risk and this can help you make the best decision. (More on bonds in lesson 12).

 
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3. Investing in Funds

Investment funds are pools of money from groups of investors invested in a variety of different stocks and bonds to make up the funds. There are a few different types of funds and they include - mutual funds, index funds and exchange traded funds (ETFs).

 
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Let’s take a closer look:

Mutual Funds

A mutual fund is a pool of funds from a group of investors set up for the purpose of buying securities like stocks, bonds etc all combined into one investment. Mutual funds are typically managed by a fund manager or a money manager associated to a brokerage firm. Their job is to make investment decisions for the fund and set the funds objectives with the main goal of making money for the fund's investors.
 

Index Funds

By Investopedia's definition, "An index fund is a type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor's 500 Index".
 

In plain english this means, an index fund can be set up to buy all the same stocks within a specific index like say the S&P 500 (explained in lesson 4); This means if you invest in an index fund tracking the S&P 500, you will be invested in every single one of the 500 companies that make up the S&P 500. Or, you can purchase a total market index fund which invests your money in equal ratios across the entire stock market based on a total market index that measures the investment return of the overall stock market.
 

Exchange-Traded Funds (ETFs)

ETFs fall under the index fund category. The key difference is they can be actively traded throughout the day at whatever the current market price is unlike mutual funds and index funds which are traded at the end of day and at the market's closing price. Because they can be actively traded throughout the day, brokerage commission fees are charged for ETFs when you buy and sell them and these costs can add up pretty quickly.

 

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Other key differences between these fund types, the mutual fund, index fund and ETFs revolve around fees and tax efficiencies - with ETF’s and index funds being more tax efficient. An investment advisor can break down the best option for you but personally I’m a fan of index funds and I'll tell you why in an upcoming lesson :)

 


4. Investing specifically for your child’s education
 

The 529b College Savings Plan

A 529b is a college savings plan that is sponsored by a state or state agency in which you can set aside funds for your child to be used towards their future college expenses i.e. tuition, books and other educational expenses. These funds can only be used at accredited 2 or 4 year colleges, vocational and technical schools, or at eligible foreign colleges. Contribution limits are typically between $300,000 and $500,000 depending on the state.
 

529b's are typically set up in the state you live but you have the option to open a 529b in a state different from where you live. Some states offer special tax deductions if you open a 529b in the state where you live but you want to make sure you are aware of all restrictions on the account including where your child can attend college as well as the fees and expenses you will be paying in comparison to the tax deduction you will get. I recommend talking through the specific with a tax accountant.
 

529bs are usually mutual funds and the tax benefits are great incentives to use them towards savings for your child's education.

 

The different investment avenues mentioned above - stocks, bonds and funds - are all components of a well diversified portfolio.

Let's get into one more avenue to invest in the stock market and that's investing for retirement.