So you have accumulated a little savings or you have heard about IRAs and want to know more about "investing." I'm writing a series about investing topics, their definitions, and what they mean.
Investing Introduction
1. Banks
2. Credit Unions
3. Mutual Fund Companies
4. Brokerage Houses
5. Investment Advisers
6. Full Service
1. Banks
Banks are businesses which make money by lending money for more than they can borrow money. In fact banks "borrow" money from you and pay you interest for the use of your money. You may have noticed that a bank does not pay you as high an interest rate as you pay for borrowing money.
I've included banks because many, most, or all of them offer some services for saving for retirements. Typically they offer instruments called "CDs" and some may offer another called a "money market."
A CD (aka certificate of deposit) is simply money which you promise to not withdraw for the period of time specified by the CD. For example, a 6-month CD means that you will not withdraw your savings for 6-months. CDs can be federally insured. CDs earn more interest than equivalent savings accounts.
A money market is similar to a savings account but the money is often not federally insured. Money markets typically earn more than savings accounts and can sometimes earn as much or more than CDs. However, they do not impose limitations on when you can withdraw your money.
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2. Credit Unions
To their customers, credit unions are very similar to banks. However, instead of operating as a for profit business, credit unions are member owned.
I mention credit unions as a separate entry because in my experience credit unions offer better rates (higher interest for savings and lower interest for loans) than banks. If you have never had a credit union bank, I recommend checking out your local credit union to see how it stacks up.
Credit union offerings are similar to banks with similar limitations.
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3. Mutual Fund Companies
A mutual fund company is a company which creates mutual funds. Mutual funds are a collection of assets (such as multiple stocks and/or bonds). Mutual funds can further be subdivided into actively managed funds and index funds.
An actively managed fund attempts to beat the average performance of the market through picking better than average stocks. Statistically speaking, actively managed funds perform worse than market or index they attempt to beat.
An index fund (also known as a passively managed fund) attempts to match the performance of the market or a market index (e.g. the S&P 500 index or Dow Jones Industrials).
Both fund types incur some management costs (the salaries for the management staff and trading costs of the assets in the fund). Actively managed usually incur higher costs than index funds. However, even among index funds, not all are created equally.
A critical performance characteristic of all mutual funds, is the management cost. This cost is subtracted from the performance of the fund's underlying assets BEFORE the investor earns any money. A 1% management fee means that you'll earn 1% less than you would have otherwise.
Two mutual fund companies with low cost funds, a wide selection of index funds, and that I have used are Vanguard and T. Rowe Price.
A mutual fund company with a wide selection of actively managed funds, very low management costs its actively managed funds, index funds, and that I have used is Fidelity.
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4. Brokerage Houses
A brokerage house is a company which offers you the ability to buy and sell assets on the financial markets (such as the American Exchange and New York Stock Exchange). Some brokerage houses (none of which I have used) are Scot Trade and E*Trade.
Brokerage houses make their money by charging their customers money for each transaction. However, the stiff competition among the brokerage houses means that even this transaction cost has gotten quite competitive. Even Vanguard (a mutual fund company) now only charges its customers $7.00 per transaction.
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5. Investment Advisers
Turn on your TV and you can't help but see investment advisers. Heck, one of these (cough cough Jim Cramer cough cough) *screams* at the TV in almost every one of his shows.
Besides the advice that you should NEVER buy a "hot stock tip" (I'm going to repeat this advice over and over), I recommend that you don't take any advice from any TV show.
However, that does not mean you should never take any advice! Two advisers that I respect very much are Value Line and Morningstar. Unfortunately both of these companies charge for membership.
I do not currently own such membership but based upon the quality of their advice I am serious considering purchasing such a membership
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6. Full Service
More astute readers may have realized that the mutual fund companies I mentioned offer brokerage services, some brokerage houses offer mutual funds, and both of these offer investment advice. In fact most investment houses now offer all services to a greater or lesser extent.
While I do think it's OK to use the same mutual fund company for your brokerage needs (and vice versa), I would not take their advice with a very large grain of salt.
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Proceed to my next investing blog on Investing Choices.
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