It's always a good idea to understand what other options are available to investors. This will help us to understand why we have chosen stocks as our investment, and also to understand the effects that changes in other markets have on the stock market.
Mutual funds are managed collections of investments that you can buy shares in. Investors pay money in, and the fund managers buy stocks or other investments (depending on the objectives of the fund) with the money. As the stocks that the manager buys appreciate, the value of the fund increases. Our stock club operates basically like a mutual fund, although with far less diversification.
Types of Mutual Funds:
Equity funds are funds that buy only stocks as investments. They typically underperform the market as a whole, although they provide much more protection from price fluctuations due to the extremely wide diversification.
Index funds mirror market performance by buying stocks in the same proportion as measured in the major indices. The most popular of these is Vanguard's S&P500 index. Historically, this fund has averaged around 11% per year, although the last couple years has been considerably higher.
Diversified funds extend their investments to lower returning bonds, money funds and other investments. They have even lower returns but are "safer".
Investors shifting between mutual funds and stocks doesn't affect the stock market much since mutual fund managers usually invest in stocks.
Bonds have fixed rate returns, which are currently in the 5 to 7% range. A bond is a debt instrument issued by an entity for the purpose of raising capital. A bond might be issued by a corporation or other entities such as state or municipal governments. Bonds normally have a set maturity (term) and interest (coupon) rate associated with them.
As bond returns go up, many people tend to shift from stocks to bonds, causing stocks to fall. As bond returns drop, many people tend to shift from bonds back into stocks, causing stocks to rise.
Usually offered by banks, CDs are short-term debt securities with a maturity from a few weeks to several years. Popular CD maturity rates are 1, 3, 5 and 10 tears. CD interest rates are generally considered conservative and the investment is considered low-risk. Interest rates are established by market demand and competition. Generally, there is a penalty for early withdrawal.
Pools of real properties usually marketed to groups of individual investors. These have become very popular lately, but don't appear to offer the sustained growth and long-term track record that the stock market has.
Many people recommend gold, silver, and other precious metals as solid investments during down markets. While this may be true, down markets are not that common and are usually short-lived. Precious metals significantly underperform the market over longer periods of time.
Futures and Options
These are fixed time investments that are extremely risky. Money is made or lost by buying and selling contracts to purchase commodities (in the case of futures) or stocks (in the case of options) at a future date and price. Although returns can be incredibly large, most contracts expire worthless. Don't even consider futures or options unless you're willing to lose it all.
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