What is a Stock? ETF? Mutual Fund? Bond?

First of all, I need to apologize for my overdone Yankee Candle references in my last letter. Apparently if you have five lit at the same time, the fumes get to your brain. I only have two lit right now after an intervention from Mike.

Now that you’ve got your brokerage account set up (click here if you missed the first newsletter in the investing series), you’re probably starting to wonder what else is out there for you to invest in. Broadly speaking, there are four primary types of investments: Stocks, ETFs, Mutual Funds, and Bonds. Thankfully, they can all be compared to breakfast foods.

But first, here are two terms that will help when reading this letter:

Index: An index is a collection of companies grouped together for a specific reason. Sometimes they are in the same industry (tech, water, gas, etc.) or a similar size by revenue. The most well known index is the S&P 500 which tracks the top 500 US companies by size. The DOW Jones Industrial Average is an index that tracks 30 (yes, only 30) large, established companies like Apple, JPMorgan, and McDonalds.

Ticker: the short abbreviation for the stock, ETF, or Fund. It can be 1-5 letters and is used to look up all the information of the product.

Stocks - the Cinnamon Toast Crunch Stuffed French Toast. Super risky order, could be amazing, could be horrible. Fortune favors the bold?

Stocks are tiny portions of companies. When you purchase a stock, you own a tiny, tiny percentage of that company. Historically speaking, those who spend days trying to find the best stocks to buy do worse than the major indexes. Warren Buffett, the world’s most famous investor, agrees with me. Recently he said, “Wilson, you are so right.” I mean, he didn’t actually say that, but he basically did when he bet a hedge fund manager $1 million that the hedge fund couldn’t beat the S&P 500 over a ten year period. Warren Buffett won.

We will go more in depth on actively managed funds and using an advisor in later newsletters, but for now, don’t go off firing your advisor! Do, however, review their fees and start to think about if you can take total control of your investments.

Exchange Traded Funds (ETFs) - the Grandma’s Sampler/All Star Special. You’re going to get a little bit of everything. You may not get enough of your favorite item, but you’ll still be satisfied.

ETFs take several companies and put a slice of them into each stock. Popular ETFs track different indexes. VOO (that’s the ticker) is a very popular S&P 500 ETF; QQQ is a popular NASDAQ ETF. They are traded in real time, just like stocks, so they are more accessible than mutual funds and less risky since they group many companies together. If one company goes bankrupt (RIP Bed Bath and Beyond) it will not destroy the value of the ETF. On the other hand, if one company goes to the moon, the ETF’s value doesn’t skyrocket either. You could purchase a bunch of shares of only one ETF (VOO, SCHK, or VTI to name a few) and still have a diverse portfolio because each share of those ETFs is actually hundreds of companies. It is a truly amazing time to be alive thanks to ETFs.

There are actively and passively managed ETFs. An actively managed ETF has a person or team deciding what companies or assets to put into the ETF. A passively managed ETF tracks a certain index and holds whatever companies are in that index. For example, VOO tracks the S&P 500. If company A grows past company B and replaces it in the S&P 500, then the ETF automatically removes company B and adds company A to the portfolio. Like I said earlier, my buddy Warren proved that passively managed funds beat active ones.

Mutual Funds - Eggs. The possibilities are endless: scrambled, over easy, poached, soft boiled, frittata, and so many more. I love some, hate others.

Mutual Funds pool investors' money together to purchase various different assets including stocks, ETFs, bonds, or even other funds to achieve the specific goal of that mutual fund. A few examples are Target Date Funds, Index Funds, or Fixed Income Funds.

Target Date Funds are a popular way to plan for retirement. If you purchase a target 2060 fund, you're saying, “I want to retire in 2060 and use this fund as my income.” Right now, 37 years out, the fund invests in riskier assets like stocks to prioritize growth. If the stock market crashes, you have 37 years to recover your investment (historically speaking you will). In 2055, the fund will primarily hold bonds to lower risk and secure your investment. These funds have a higher expense ratio as they are actively managed, but allow you to sit back and let the experts balance your portfolio.

Index Funds are exactly what they sound like, mutual funds that track a certain index. “Wilson, you just talked about ETFs that do the exact same thing! Why would I buy a fund instead of an ETF?” Great question, sometimes the expense ratio of a fund is less than an ETF. Fidelity’s Zero Funds allow you to invest at zero cost to you. No ETFs offer that. However, funds are not traded in real time. If you order a fund today, you will not actually purchase that asset until after the market closes and your brokerage processes your request. Also, if you have a Schwab brokerage account, you won’t be able to purchase the Fidelity fund.

Fixed Income or Money Market Funds purchase mostly bonds to maximize consistent payments. They are not the same, but given the fact that I started this letter talking about stocks, they are close enough to group together. I currently keep my emergency fund in SWVXX. Fidelity offers SPRXX as a comparable alternative. But what is a bond?

Bonds - Black Coffee. This isn’t a breakfast food. It serves a crucial part of the holistic meal, but if that’s all you’ve got, you’re going to be hungry.

Simply put, bonds are loans. If you buy a bond, you are lending money to an entity at a fixed interest rate and period of time. Typically, the entity is a government, but companies also sell bonds to raise money. Generally speaking, bonds do not increase in value. They have a very small but consistent return.

Like coffee, bonds serve a distinct purpose. Although their payout is small, the risk is even smaller. If you are young, bonds can be a good place for your emergency fund. If you are in retirement, bonds can make the majority of your portfolio as they provide consistent, reliable fixed income with little risk (unless the United States Government defaults on its debt…).

That is a quick summary of the four main investment options. The rabbit hole only gets deeper from here. Thankfully, Mike and I will keep showing up in your inbox every Thursday morning!

Call to Action

Start a “watchlist” on your brokerage account to keep track of all the ETFs, Funds, or Stocks you may want to invest in.

What We’re Reading/Listening To:

If you’re curious about bonds, interest rate hikes, and their connection to the recent bank failures, read this.

Debrief on Deck

Next week, I am diving into Credit Card Points. Spoiler: I love credit cards, but I don’t know how to “credit card hack” because I don’t think it’s worth it. This letter will provide an argument to just have 1-3 credit cards.

As always, please reach out to us with any questions or comments you have. You can reply directly to this email or find us on social media (Twitter and Instagram).

Until then, stay the course.

Disclaimer