When it come to equity investing for beginners; two types of financial instruments available to the general public. Which are Mutual Fund and ETFs.

What are Mutual Funds?

In the United States, mutual fund is registered with the Securities and Exchange Commission and overseen by a board of directors, to make sure that the fund is managed in the best interests of the fund’s investors. The fund manager manages fund’s investments in accordance with the fund’s investment objective.

Mutual funds provide:

• Diversification
• Professional management
• Service and convenience
• Government oversight

Disadvantages:

• Fees
• Less control
• No opportunity to customize

Who should invest in Mutual Fund?

If you are a beginner who does not want to manage your financial investment; Mutual Fund is a way to begin. In my opinion, ETFs is a better alternative because many market researchers say that majority of Mutual funds over the years is underperforming compare to the market return. Before you make an investment decision lets take a closer look on ETFs.

What is ETF?

An exchange-traded fund (ETF) is an investment fund traded on stock exchanges, just like stocks. An ETF holds assets such as stocks, commodities, or bonds, and trades close to its net asset value over the course of the trading day. In 1993, the first ETF appeared in the United States as the Standard & Poor’s 500 Depository Receipts (SPY), The SPY tracks the S&P 500 index at 10% of its value; SPY has the same component of stocks in the S&P 500 index. For instance, when you do a search on SPY you will see as of today it trading at 129.13 and the S&P 500 index is at 1292.08. In recent years, ETF is increasing popularity, ETFs offer public investors an undivided interest in a pool of securities and other assets similar in many ways to traditional mutual funds, except that shares in an ETF can be bought and sold throughout the day like stocks on a securities exchange.

The advantages are:

• Diversification
• easy to manage
• trade as stock
• low cost

The reason I think ETF is a better choice for individual is that the cost is really low, unlike Mutual fund that charge you 1-2 % annually and other service fees, ETF annual expense is around .5%. Now a day many ETFs that track global market or sectors, for example if you want to invest in energy companies you can purchase Energy SPDR – XLE. XLE’s holding are energy companies that primarily develop and produce crude oil and natural gas, and provide drilling and other energy-related services. Leaders in the group include ExxonMobil Corp., Chevron Corp, and ConocoPhillips. ETF is a very flexible alternative to mutual funds; you have more control on your investment. You can allocate your money through various ETF for diversification and the cost expense is the same as buying a stock which somewhere under $10 depend on your broker.

Here are couple of popular ETF family:

• Vanguard
• PowerShares
• Ishares

I believe ETF is a great way to invest for those whom just start out; if you do not want to pick your own stock portfolio just invest in SPY, it contain 500 companies and your return will be equal to market return. As I have mention earlier, majority of Mutual fund’s return are underperforms compare to the market why you pay 1-2% fee extra for it. I know 1-2 % is not a lot of money, imagine you invest for 20 years that small difference will be very significant for you retirement. A 2% difference in return compound 20 year will earn you 50% more money in your retirement.

In the end, I hope all of you enjoy my writing and leave me some comments. What kind of investment vehicle you are using? How your investments perform in the past? I wish we can build a great community to learn from each other. Mean while good luck to you all.

In my last post I covered inflation, in this post I am going to show you what returns you should expect in different types of financial investments.

The historic return on various types of investment products

Debt Investment

What is bond?

Bond is an IOU. You loan money to the U.S. government, a state, a local municipality or a big company like General Motors.
When a bond is issued, the price you pay known as the face value of the bond. Mostly priced at $1000, the issuer of the bond promises to pay you back on a future day – maturity date at a predetermined rate of interest—coupon

Here is a simple example:

You buy a company XYZ Bond with a $1000 face value at 4% coupon and a 10-year maturity, for the next 10 years period you will be getting $40 per year from Company XYZ and you will get back your $1000 dollar investment in the end. So in the end of 10 year you will have $1400 in cash.

Below is the current interest rate of bonds

3-12 month US Treasuries at 0%

2 years US Treasuries at 1%

10/30 years US Treasuries at 3.04%

Investment grade corporate bonds at 1-4.51%

You can find more information about bonds here.

Real Estate investment return

I believe most of you know something about real estate investment, so I just going to give a brief example:

Let’s say you buy a house for $200,000 and rent it out for $600 per month for a year. In the 2nd year you sold it for $210,000. Here is how to calculate the returns on investment:
$7,200+$10,000=$17,200 profit then divide by $200,000 which is 8.6 % ROI
The return on real estate is around 8.6% per year for the past 20 some years

Equity Investment

Given that many stocks are in the stock market, so I am going to use the S&P 500 index for this research. I find that over the last 100 years the annualized return for the market is 9.67 % and 6.25% if adjusted with inflation. You can find more information on stock market return here.

what kind of investment products do you prefer?

If the inflation is 3.4% as of today, investing in bond is a very bad choice because it produces a negative return. In my opinion the best type of investment is equity investment because it out run inflation over the last 100 years. If I have to choose between real estate or equity investment I prefer equities. The return on investment in equities is higher compare to real estates. Stock market investment is highly liquid you can get in and out easily, and you can invest in stock for a small amount of money. In my opinion, stock market is the best investment on there.

How inflation relates to investment choices?

So what is inflation? Years ago with a hundred dollar bill we can buy weeks of grocery. Nowadays the same amounts of money hardly buy us anything. When I got my first car I filled up my tank of gasoline for around 20 bucks. Now it cost me more than double of what I paid in the past. Why do you think the same bills in the past buy us less goods and services now?

The cost of living is increasing because of inflation. Inflation means a sustained increase in the general level prices for goods and services. It measured as an annual percentage increase to the prior year. The purchasing power of a dollar decrease as inflation increase; however, you would not notice much from time to time, but over a long period of time your paycheck purchasing power would decrease substantially as the prices of goods and services keep going up.

How inflation relate to investment choices? Since youth, my parent had taught me that I needed to save money in the bank. However, is this the correct way to invest our money for the future provides with rapid increase cost on food, clothing, transportation, education, healthcare, and housing etc… Major banks in the U.S offers CD at around 1 % interest; however, according to the bureau of labor statistics as of today the inflation rate measure by CPI is at 3.4 %. What does this mean to us? It means for every hundred dollar we saving in the bank will lose around 2 dollar in value per year. How do you like the idea about saving in the banks now? I don’t know about most of you but I invest because I want a positive real return.

There are many financial instruments available in the financial market which one do you prefer?

I began my financial career in the early 2000s, after I read a book named Day Trading Online. I liked the idea of making money through trading in the stock market; then, I opened a stock brokerage account and believed that Stock investment is easy and profitable. Unlike other first timer I didn’t have any beginner’s luck, and I lost my small account on a couple of penny stock trades. Others may viewed my experiences as unfortunate; however, I felt fortunate because without those valuable experiences in my early investment career. I wouldn’t have taken the time and effort to train my self to be a better and wiser investor as today.

After those invaluable experiences, I started to engage in the study of financial market. Over the years I had filled my bookshelf with series of financial rated books. In 2005, I encountered an option trading education firm that taught various option strategies and I met a lot of professional option traders. I had learned lots of effective techniques and sophisticated option strategies. I had used most of the investment strategies I learned, some produced great returns and other didn’t. There after I reviewed and analyzed all these trades, and then I developed a great system that combined sound stock investment with sophisticated option trading system to obtain superior returns. The system allowed me to receive increasing passive income, which allowed me to reinvest in more income producing stock so that I would have more passive income for my rainy days.

In this blog, I would like to share my investment ideas to you and I wish all of you post comment and investment ideas so that each one us can benefit and become a better and wiser investor together. In the end, I believe that anyone with a burning desire to success will be successful and I wish all of you could pursue your dreams.