Eric Tyson - Mutual Funds For Dummies

Besides occupying different industries, companies also vary in size. In the financial press, you often hear companies referred to by their market capitalization, which is the total value of their outstanding stock. This is what the stock market and the investors who participate in it think a company is worth.

You can choose from two very different ways to invest in bonds and stocks. You can purchase individual securities, or you can invest in a portfolio of securities through a mutual fund or exchange-traded fund. I discuss stock funds in Chapter 13and individual securities (and other alternatives to funds) in Part 2.

Overseas or international investment is a potentially misleading category. The types of overseas investment options, such as stocks and bonds and real estate, aren’t fundamentally different from your domestic options. However, international investments are often categorized separately because they come with a different set of risks and rewards.

Here are some good reasons to invest a portion of your money overseas:

Diversification: International securities markets don’t move in lockstep with U.S. markets, so adding foreign investments to a domestic portfolio generally offers you a smoother ride over the long term.

Growth potential: When you confine your investing to U.S. securities, you’re literally missing a world of opportunities. The majority of investment opportunities are overseas. If you look at the total value of all stocks and bonds outstanding worldwide, the value of U.S. securities is now in the minority (at about 40 percent). The United States isn’t the world — and some overseas economies are growing faster.

Some people hesitate to invest in overseas securities because they feel that doing so hurts the U.S. economy and contributes to a loss of U.S. jobs. Fair enough. But I have two counterarguments:

If you don’t profit from the growth of economies and companies overseas, someone else will. If money is to be made there, Americans may as well make some of it.

The United States already participates in a global economy — making a distinction between U.S. companies and foreign companies is no longer appropriate. Many companies headquartered in the United States also have overseas operations. Some U.S. firms derive a large portion of their revenue and profits from their international divisions. Conversely, many firms based overseas also have operations in the United States. Increasing numbers of companies are worldwide operations.

Dividends and stock price appreciation recognize no national boundaries! You aren’t unpatriotic if you invest globally. Profits from a foreign company are distributed to all stockholders, no matter where they live.

Perhaps the most fundamental of ownership investments, real estate has made many people wealthy. Not only does real estate produce consistently good rates of return (averaging around 8 to 9 percent per year) over long investment periods, but you can also purchase it with borrowed money. This leverage helps enhance your rate of return when real estate prices are rising.

As with other ownership investments, the value of real estate depends on the health and performance of the economy, as well as on the specifics of the property that you own:

If the local economy grows and more jobs are being produced at higher wages, real estate should do well.

If companies in the community are laying off people and excess housing is sitting vacant because of previous overbuilding, rents and property values are likely to fall.

For investors who have time, patience, and capital, real estate can make sense as part of an investment portfolio — check out Real Estate Investing For Dummies (Wiley), which I coauthored with Robert Griswold. If you don’t want the headaches that come with purchasing and maintaining a real estate property, you can buy mutual funds and exchange-traded funds that invest in real estate properties and related companies (see Chapter 14).

Whenever bad things happen, especially inflation, credit crises, and international conflicts, some investors seek out gold, silver, and other precious metals. Over the short term, these commodities may produce hefty returns, but their long-term record is more problematic. Over the very long-term, gold has kept investors just up with the rate of inflation — eking out an annualized return that is 0.5 percent per year above the rate of inflation. See Chapter 14for all the details and how you can diversify your portfolio by using specialty funds investing in this sector.

With the proliferation of cryptocurrencies, I must briefly discuss investing in currencies. There are very few funds that invest in currencies, and they all have pretty dismal or, at best, mediocre long-term track records. This makes sense because currencies — which are essentially keeping your money in cash — are poor investments. Over the long term, for example, the purchasing power of holding the U.S. dollar declines at a rate of about 1.5 percent per year.

Will cryptocurrencies be any different? By financial market standards, their track record is quite short. Believers point to the crazy price increases enjoyed by select cryptocurrencies (such as Bitcoin and Ethereum) in the marketplace of now more than 17,500 cryptocurrencies, and more are coming quickly.

The explosion of cryptocurrencies is in itself revealing. Crypto creators come up with an idea for how to promote a new crypto, and by getting in on the ground floor, they hope to reap large profits if others buy in and hopefully drive up the price.

Annuities are investment products with some tax and insurance twists. They behave like savings accounts, except that they should give you slightly higher yields, and insurance companies back them. As with other types of retirement accounts, the money you put into an annuity compounds without taxation until withdrawal. However, unlike most other types of retirement accounts — 401(k)s, SEP-IRAs — an annuity gives you no upfront tax deductions for your contributions.

Annuities also charge relatively high fees. That’s why it makes sense to consider contributing to an annuity after you fully fund the tax-deductible retirement accounts that are available to you. The best annuities available today are distributed by no-load (commission-free; see Chapter 7for more on load and no-load funds) fund companies. For more information about the best annuities and situations for which annuities may be appropriate, be sure to read Chapter 15.

Some insurance agents love to sell cash-value life insurance. That’s because these policies — usually known as universal, whole, or variable life policies — combine life insurance protection with an account that has a cash value. They generate big commissions for the agents who sell them.

Cash-value life insurance isn’t a good investment vehicle. First, you should be saving and investing through tax-deductible retirement savings plans, such as 401(k)s, SEP-IRAs, and IRAs. Contributions to a cash-value life insurance plan provide you no upfront tax benefit. Second, you can earn better investment returns through efficiently managed funds that you invest in outside of a life policy.