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Chapter 4
Stock Investment Vehicles
As alluded to before, there are a variety of ways to invest in stocks or “the stock market.” Here are the most common ways:
- individual stocks
- mutual funds
- open end
- closed end
- Exchange Traded Funds
- Futures and options
We won't talk about the last one, as futures and options for the average stock investor are more speculation than investment.
There are also different types of investment accounts, such as taxable brokerage accounts, accounts you open with a mutual fund company, IRA accounts, Sharebuilder accounts, and 401k accounts.
Let's start at the beginning. Individual stocks can be purchased in a few forms: Directly from the company (direct stock purchase programs), through a DRIP, through a broker, or through a retirement account such as a 401k or IRA. The price you pay is based upon the supply and demand of the particular stock you're purchasing; there is an “ask” price and a “bid” price, the difference being the so-called “spread.” There's almost always a commission expense incurred.
Mutual funds are nothing more than funds investment companies put together that pool individual investors' money to buy individual stocks. There are all sorts of mutual funds: Actively managed funds that focus on a sector, or a country or region, large-cap, small-cap, and medium-cap; passively managed funds that aspire to mirror a particular index, like the S&P 500; you name it, you can find it in a mutual fund!
Open-ended mutual funds are priced solely on their Net Asset Value (NAV), which is determined by the total value of the fund (the addition of each stock's price per share times number of shares) divided by the number of outstanding shares. If you invest one hundred new dollars in a mutual fund, the mutual fund buys $100 worth of one or more stocks (it can also keep your investment in cash) and the total value of the fund rises by $100. Tomorrow, if the fund buys 20 shares of a stock at $5, the NAV will be adjusted due to the new number of outstanding shares and added value that came from your investment in cash.
Closed-end funds have a fixed number of shares outstanding; that is, fund managers do not buy or sell shares in the companies they initially held. Throughout the life of the fund, the same companies are held. The value of the fund may equal the equivalent NAV of the underlying shares or it may trade at a premium or at a discount. The price is driven by the relative prospects of the underlying investments.
Mutual funds are great to use with dollar-cost averaging.
Exchange Traded Funds, or ETFs, are traded just like individual stocks. They're a great way to invest lump sums of money in an index, for example, because their management fees are very low and you pay a one-time commission to buy them. They're bought just like stocks and offer all the advantages and disadvantages (except they do offer diversification), but they are comprised of a basket of individual stocks like a mutual fund.
These are all the stock investments you should consider. Now, we move on to the various accounts.
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