A fundamental building block of a successful retirement portfolio is stocks. How to invest in stock, however, is a tricky question. Beginning investors are met with a range of possibilities, each with their own strengths and weaknesses.
These days, people own mostly stocks and use bonds as a counterbalance. Nevertheless, in even the most conservative retirement portfolio you will (and should) find some stocks.
So, how to invest in stock? Here’s a simple breakdown:
1. Buy shares
How-to: Buy them through your broker or online using the ticker symbol.
The good: Direct ownership can be a great source of wealth-building power, assuming you buy at a low value and hold it long enough to realize a gain. In the meantime, many firms pay dividends.
The bad: Stocks can be volatile, so holding them after they fall below your purchase price is emotionally taxing. Dividends can be cut or halted altogether. Trading triggers taxes in non-IRA accounts, and trading fees add up.
The ugly: People love a winner, so they love stock picking and tend to buy the stock everyone else is buying — after which it crashes back to earth. Worse, individual companies can fail, making your holding worthless.
2. Buy stock mutual funds
How-to: Similar to buying individual stock, a ticker represents the fund. Underlying that ticker is a manager who buys and sells a variety of stocks on your behalf. Pricing is end of day, as with all mutual funds.
The good: If you believe the manager is talented, you get to outsource the trouble of stock selection. Owning a mutual fund also offers diversification.
The bad: Fund fees. Your manager’s performance will be stunted by the cost of his or her advice.
The ugly: Seven out of 10 stock fund managers fail to beat the broad market benchmarks in any given year. Even a “hot” manager can fall behind the eight ball.
3. Buy index funds or ETFs
How-to: These also trade as tickers. There are differences, but one key distinction is that index funds are priced end of day and ETFs trade all day, like common stocks. Both types have very low fees, and most are built to track broad, well-known indices.
The good: You don’t get an “average” return, you get the market return. Over time, research has shown, market returns dramatically outpace active investor returns.
The bad: You are not buying any advice at all, which is why they are cheap. Keep in mind that a simple S&P 500 index fund by itself is not a portfolio, it’s just stock exposure at a low cost.
The ugly: There are hundreds of ETFs out there, some of which are priced at the cost of actively managed funds. Also, some are little more than trading strategies using an ETF structure. Be sure to buy an ETF you understand.