Workable Wealth Investing Series: What’s in an Investment Portfolio?

Welcome back to the third part of our investment lexicon series. In part one, we introduced the concept of financial markets and discussed their broad reach. In part two, we looked at the U.S. stock market and its many intricacies, including what it is, ways of tracking it, and strategies to approach investing in it. Today, we’ll explore the ways you can participate in the stock market, namely the creation and management of your investment portfolio. What is your portfolio? What is it made of and how can you customize it to fit your needs? Let’s get to it.

Breaking Down a Portfolio

Your investments need a place to live. A portfolio is the place where you house and manage your investments. It consists of all your securities including stocks, bonds, cash, real estate, commodities, mutual funds, exchange-traded funds (ETFs), and more.

Your portfolio is where you customize your investments to suit your needs. It’s how you acquire, sell, and manage your assets, and is your small piece of the market. Portfolios are managed by individuals, money managers, or financial planners, and an investor can have multiple portfolios that serve distinct purposes.

When creating a portfolio, it’s important to keep your risk tolerance, investment goals, and time horizon in mind. A portfolio for a conservative investor will look completely different from an aggressive or moderate investor and that’s good. Your portfolio really should be tailored and customized to your needs and properly adhere to your risk comfort level.

An Overview of Securities

A security refers to something with financial value that can be bought or sold. This is a broad category that encompasses many aspects of the financial market including stocks, bonds, ETFs, and mutual funds. The goal of securities is for companies to raise money in order to keep them running. There are different categories securities fall into: equity and debt.

Equity securities give the investor ownership rights. The most common type of equity security is stock. Most equity securities don’t pay investors regularly in the form of dividends (but this isn’t always the case), and investors tend to make money on capital gains (i.e. the sale of the security at a higher price than the original purchase price).

Debt securities don’t represent ownership, they represent money that is borrowed and will be paid back at a later date. Great examples are bonds and certificates of deposit (CDs). Debt securities often pay investors interest and are usually issued for a certain period of time at which point the investor can reclaim them.

What is Stock?

Stock is a type of investment that represents ownership of a given company. When you buy stock, you are purchasing a share (or shares) in a company that supplies the company with an influx of capital. The goal for companies is to raise money to continue operations and expand their enterprise; the goal for investors is to support companies that will grow in value and eventually make the investor money when the shares are sold.

Public corporations allot a certain number of shares for sale on the stock market. Investors then buy and sell shares on the market with the hope of profits. Many investors hold onto their stock hoping the price (and value) will rise, but that doesn’t always happen, of course. Sometimes companies lose money or go out of business completely which makes stocks a riskier form of investing.

There are two main types of stocks:

Common stocks are shares of a public company and the most prevalent form of stock investing. Dividends are possible but not guaranteed and shareholders have voting rights. Common stock carries more risk but tends to outperform its preferred counterpart.
Preferred stocks pay fixed dividends to investors. This fixed-income security often sits in between common stocks and bonds in terms of risk level. The downside is shareholders don’t often have voting rights which eliminates their “say” in the company.

Stocks also have other categories like company size, style, industry, and location.

It’s key to create a strategy around your stock holdings and understand that in order to make a greater profit, it often means holding onto the stock for a longer period of time. With higher volatility, stocks are a good long-term investment as investors have time to weather market fluctuations.

What is a Bond?

A bond is a type of debt security with a structure similar to a loan. When you buy a bond, you are loaning money to a company or government who has promised to pay it back at a certain time. Bonds are considered fixed-income securities because they pay their investors interest, either variable or fixed, along the way.

Bonds are used by corporations and the government alike to help fund their ventures and are often publicly traded. The price of bonds varies depending on many factors. These include the time it takes to mature (i.e. when the bondholder will receive the face value of the bond), and the credit quality of the bond issuer — meaning the likelihood that the bond issuer will repay the loan.

Bonds that pay higher interests to investors often have lower credit ratings, meaning a higher chance of default and longer maturity time frames. Those types of bonds are known as high-yield bonds. The highest quality bonds have good credit ratings and are known as investment grade, and these are backed by the U.S government or extremely stable companies.

Bonds are subject to change based on interest rates. Each bond’s sensitivity to interest rate fluctuations differ but it’s relevant to know they exist. Bonds come in a few different categories:

Corporate bonds, which are issued by companies
Municipal bonds, which are issued by cities
Government bonds, which are issued by the government
Agency bonds, which are issued by agencies

Each type carries its own set of risks, rules, and regulations. In general, bonds are a safer form of investing but they generate much lower returns compared to the stock market. For example, stock market returns tend to be about double bond returns.

What is a Mutual Fund?

A mutual fund is an opportunity for multiple investors to pool money together that goes towards a certain basket of securities. Mutual funds are operated by money managers and are designed to achieve a certain investment goal.

These funds are a good way to invest in multiple companies at once without having to purchase individual shares of each. One share in a mutual fund represents a broader investment in the market as a whole because mutual funds have a mix of investments like stocks and bonds. The value of a mutual fund is determined by the market capitalization or total value of the fund.

What is an Index Fund?

An index fund is a type of mutual fund designed to track larger market indices like the S&P 500. By investing in an index fund, you can gain broad market exposure while also keeping costs low. How are costs so much lower? You won’t face as many operating costs and your portfolio won’t change as much.

This can be done through passive investment (remember that strategy from part two?). Passive investing takes market timing out of the mix and focuses on the long-term strategy of market holdings. With an index fund, the account manager builds a fund that tracks or mirrors a particular index; this takes out the guesswork and gives investors a more reliable form of investing.

It’s hard to say for sure which method produces the highest returns. In recent years, however, passive investment strategies have been more cost-effective and produced higher returns than actively managed funds which are more costly to operate. Remember, finding the right investment plan for you can be done by assessing your goals, building a portfolio that aligns with your risk appetite, and keeping your investment timeline in mind.

Fees to Learn

Most types of investing will cost you something and you should know the different types of fees you may be responsible for. Before investing in any fund, read the prospectus. This document outlines all fees the fund will charge you, keeping you more informed. Of course, your financial advisor should also make you aware of these fees, but it’s always good to do due diligence.

The first fee to know is an expense ratio. This represents the fee you’ll pay for the management and operation costs of the fund. Some funds have high expense ratios whereas others are much lower.

Keep in mind expense ratios are often taken out as percentages of your returns, so the lower the fee, the better your net returns.

Sometimes funds will have unexpected fees, most notable 12-1b fees for marketing and fund promotion. This fee can’t exceed 1% but it can still add up.

Index funds tend to have much lower expense ratios than actively managed funds, coming in around 0.02% as opposed to .75% or higher.

The Bottom Line

Understanding the different elements of your portfolio can empower your investing strategy decisions and inform the types of investments you choose to buy. Have questions? Give us a call today. We’re happy to walk you through your current portfolio, and help tailor your strategy to better achieve your goals.

Disclosure: Abacus Wealth Partners, LLC (Abacus) is an SEC registered investment adviser with its principal place of business in the State of California. Abacus may only transact business in those states in which it is notice filed, or qualifies for an exemption or exclusion from notice filing requirements. This brochure is limited to the dissemination of general information pertaining to its investment advisory services. Any subsequent, direct communication by Abacus with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Abacus, please contact us or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov).

This is not an offer to sell any type of security, and there is no investment currently available through Abacus. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell this security. This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. Information was based on sources we deem to be reliable, but we make no representations as to its accuracy. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this article will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.

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