The simplest type of investing is a savings Account.  You put money in a bank, and the bank pays you a very small (often minuscule) amount of interest in order for you to put your money there.  They then lend that money out to other people for a much higher interest, and that’s how banks make some of their money.  The first $250k that you put in a bank account is insured by the government (called FDIC insurance); so if the bank goes under, you get up to $250k from your account back.  If you want to protect your money and you have more than $250k in one bank, split it into multiple banks; each account will be insured for $250k.  Banks can also do tricks to divide up your money within their bank and have each account be insured (effectively, they’ve created multiple banks within a bank to take advantage of FDIC insurance).  You’ll have to talk to a money manager at a bank if you want to take advantage of this.

A money market account is like a savings account with two main differences:  1) it pays slightly higher interest rates, and 2) it requires a (significant) minimum amount of money to create a money market account (several thousand dollars).  It is also FDIC insured.

A Certificate of Deposit (CD) is an account that you can get at your local bank as well, and it’s also FDIC insured.  It typically pays higher interest than a money market account.  The main difference is that you commit yourself to a length of time.  You might buy a CD for a year; the interest rate is locked in on the day that you purchase the CD.  Then, you don’t have access to that money for a year, during which time your account accrues interest.  At the end of the year, you’re able to withdraw your money and the interest accrued.  If you withdraw before that time, you have to pay a penalty fee.  You can get CDs for different lengths of time; the longer the amount of time, the higher the interest rate of the CD.  I have found that you can bargain over the interest rate of the CD; a bank manager can often increase the interest rate slightly for customers, so it’s worth it to ask if he’ll/she’ll do that for you.  With CDs, it is often the case that when the CD matures (meaning that the length of time you committed your funds to the CD) then you have a few days to deal with the money before it gets recommitted to another CD of the same length of time (with whatever the new interest rate is).  When you purchase a CD, the interest rate is “locked”; this means that the interest rate is specified at the time that you purchased the CD.  If the interest rates of the bank go up or down while you own the CD, it doesn’t change the interest rate of the CD.  If you think that interest rates will be going down, then a CD may be a good investment.

With a standard savings, money market account, or CD you are taxed on the interest.  So every year, you get payments and are taxed on the amount you receive.

With an Individual Brokerage Account, you can purchase stocks and bonds.  Any bank will let you do that.  There are also investment companies like Fidelity and Schwab.  (There are a million of them, and I have no particular allegiance to any company.)  A brokerage account is no longer FDIC insured.  Let’s talk about stocks and bonds.

A stock is a piece of ownership of the company.  When you buy a stock, you are purchasing ownership of the company.  I own some Tesla stock, so I am a part owner of Tesla.  There are different types of stocks: voting shares and non-voting shares.  Voting shares let you control the company in some way (perhaps by voting on who the CEO will be); non-voting shares do not.  Since you are given some control, voting shares are more expensive.  Alphabet (Google’s parent company) has shares of type A and type C; with A shares (GOOGL) you can vote, with C shares (GOOG) you can’t.  The A shares cost more than the C shares.  Some companies provide dividends to their shareholders.  When a company makes a profit, it’ll distribute that profit to shareholders.  So if you own stock, you might get some money in dividends from the companies that you own.  Like the interest from a savings account, you have to pay taxes on dividends gained from stocks in an Individual Brokerage account.  You might ask “Why would I buy shares in a company that didn’t distribute dividends?”  That’s a great question; in this case, you’re hoping that the stock price rises and someone else will purchase it from you.  Apple is a company famous for not distributing dividends.  Apple will often buy back outstanding shares, and this increase in demand drives the price of the stock up, which is one reason people make money on Apple stock.  Additionally, as we’ve discussed, shares of the company mean you are a part owner of the company.  And so, if the company had to be liquidated, you would be entitled to a proportional percentage of the value of the assets of the company.  Apple owns a lot of land, buildings, vehicles, and Intellectual Property which could be sold if the company went under (which, by the way, I don’t see happening anytime soon in spite of several mistakes they’ve made).

The price of a stock often gets all the attention, but there’s another number that matters just as much: the company’s market cap.  The market cap = (number of shares) x (price of shares).  The market cap tells you how much the market is valuing a company (in dollars).  The share price tells you how the company has been partitioned for sale.

Bonds are issued by organizations to raise money.  When an organization wants to borrow a lot of money, they will issue bonds.  If you want to lend that organization money, you can buy a bond from that organization.  A familiar example is a “savings bond”; this is a bond issued by the US federal government to raise money.  The bond has an interest rate associated with it.  The price of bonds are often tied to interest rates.  The trend is that when interest rates (specified by the Federal Reserve) increase, then the price of existing bonds decrease (because it now costs more to borrow).  And when interest rates decrease, then the price of bonds increase.  This trend is referred to as gravity.  Note that it’s a trend and not a law of physics; there have been plenty of times in history when interest rates went up and bond prices went up and vice versa.  There’s a problem with investing in bonds and dropping interest rates; if you’re a bondholder and the interest rate goes down, some institutions may try to pay off the bond and borrow at the lower rate (essentially refinancing their loan to you).  If you decide to buy a bond, see if there are any pre-payment penalties so that you profit even if the interest rates go down.  A major risk with bonds is that the institution goes bankrupt or is unable to pay back the bond.  If this is the case, you lose your investment in the bond.  For example, the local community college in my home town borrowed $230 million by issuing bonds in 2016 [1]; they are expected to have to pay back approximately $500 million to bond holders.  If, for some reason, the income of the college was drastically reduced from what they expected (e.g. the housing market drops reducing the amount of property taxes in the area, government incompetence at the state level leads to reduction of funds distributed to community colleges) then the college may not be able to pay back the bonds and the investors would lose their money.  (I’d like to note that the college has issued several bonds for hundreds of millions of dollars each; the college is heavily in debt.  You’d probably like to consider the total debt before deciding whether or not to purchase a bond from an institution.)

There are special bonds issued by the government with tax benefits.  For example, there are bonds issued by municipalities where the interest is not taxed by either the state or the federal government.  This is an additional consideration that you might want to note.

Another general trend (again, this trend has been violated many times over throughout history) is that when stocks go up then bonds go down and vice versa.

Dividend Reinvestment Plans (DRIP) let you reinvest any dividends you receive back into the stock.  The Royal Bank of Canada (RY) distributes dividends every quarter.  If you owned stock in RY and had a DRIP setup, then those dividends would be used to purchase additional shares of RY, which would then increase the percentage of dividends that you’d get next time around.  With a DRIP plan, you will almost certainly purchase partial shares with the dividends that are distributed to you; I don’t know of another way to do that.

Another commodity that you can trade is minerals.  You can buy and sell silver and gold.  There are two ways (that I know of) to do this.  One is to actually purchase the mineral.  For example, you can go to a local coin dealer or visit Ebay and buy gold coins.  These coins are minted by governments; the purpose of government minting is to encourage you to trust that they have the amount of mineral that is claimed (e.g. 1oz of gold).  Alternatively, you can purchase a fund that tracks the price of the mineral.  For example, GLD tracks the price of gold.  So when gold goes up, GLD tends to goes up and vice versa.

You might think that it’s bad to “put all your eggs in one basket.”  So if you have a relatively small amount to invest, you might not want to put it all in one company.  This idea is called diversification.  To diversify your portfolio means to buy a bunch of different types of stuff.  Lots of people think that diversification is good.  If you’d like to diversify, a very easy way to do that is to purchase a mutual fund.  With a mutual fund, people contribute to one giant pile of money, and that money is used to buy up a whole lot of different stuff.  Once the fund is created, you can buy or sell parts of it like any other stock.  Each fund will have its guiding principles (what it decides to invest in); there are funds to invest in energy companies, technology companies, transportation companies, entertainment companies, etc. For example, you could buy mutual funds of bonds with tax benefits; two examples are Nuveen Advantage California and Vanguard Intermediate-Term Tax Exempt Fund.  The benefit of purchasing mutual funds is that you get to diversify your portfolio quite a lot.  The down side is that you have to pay a manager to manage the fund.  The fees for mutual funds can vary wildly; I’ve seen exorbitant fees (that I consider gauging) for mutual funds.  I’ve also seen very reasonable fees.

There are groups of companies with famous names: S&P 500, Dow Jones Industrial Index, NASDAQ.  Each of these names describes a different group of companies.  The Dow Jones Industrial Index is meant to quantify how well the industrial sector is performing.  NASDAQ is meant to quantify the technical sector.  And the S&P 500 is meant to show how the 500 “best” companies are doing.  There are mutual funds that try to follow the performance of these groups.  You might think that since the groups are already established, there wouldn’t be much for a manager to do and so he shouldn’t get paid much.  You’re right!  In fact, a computer can manage mutual funds that follow these groups.  Mutual funds managed by a computer are called Exchange Traded Funds (ETFs).  SPY is an ETF that tracks the S&P 500 and DIA is an ETF that tracks the Dow Jones Industrial Index; the fees for ETFs (computer managed funds) are much lower than those of funds managed by humans.

You can hold money market accounts, stocks, bonds, mutual funds, and exchange traded funds in individual brokerage accounts (along with a bunch more stuff that I tend not trade in).  If you do, then you get taxed on money distributed to you as dividends or interest.  You also get taxed on any profit you generate from trading.  For example, if you purchase stock XYZ at $90 and sell a few years later at $100 then you will have to pay taxes on $10 profit per share.  The amount of taxes you have to pay depends on the length of time that you held the stock; if you held it for less than a year, then you have to pay “short-term capital gains” taxes which is a higher rate than “long-term capital gains” taxes (applicable when you hold stock for longer than a year).

Individual Retirement Accounts (IRA) are a way of avoiding taxes.  In order to encourage people to save for retirement, the government has created IRAs.  There are two types of IRAs: traditional and Roth.  With a traditional IRA, you are able to deduct the money that you put into the account from your taxes.  However, when you pull the money out at retirement (after it has accrued interest) you must then pay taxes on the whole amount.  The reason this might be beneficial is if you think that you’ll be subject to a lower interest rate during retirement than you are when you are employed.  With a Roth IRA, you are not permitted to deduct the amount you put into the account from your taxes.  However, when you pull the money out (including the interest) you are not taxed.  The stipulation is that you don’t pull the money out until you are of retirement age, which is currently 59.5 years old.  If you pull the money out of an IRA before your retirement age then you have to pay taxes on the amount distributed. There are limits to how much you can contribute to an IRA.  You can only contribute to a Roth IRA if you make less than a specified amount (currently approximately $120k for someone who is single and less than that for a traditional IRA).  In either case, the maximum you can contribute to an IRA is currently around $6k (this amount is changing every year).

Usually when you trade (purchase or sell a commodity), there is a fee for trading.  This fee is called a “commission.”  This commission is relatively modest (e.g. $10 per trade).  However, there are ways to avoid paying a commission.  If your account is at Fidelity, you are permitted to purchase and sell Fidelity mutual funds for free.  Other banks might have the same benefit.  It’s something to note.

Rather than invest all your money at one time (and one price), you might want to average the prices over a time period.  This is called “Dollar Cost Averaging.”  If you want to purchase 100 shares, you might buy 10 today, 10 tomorrow, and 10 every day until you hit 100.  The downside of dollar cost averaging is the increase amount you spend on commission; you pay a commission per trade, and so with our example, the commission paid would be multiplied by 10 to purchase the same number of stocks.

There are also company retirement accounts: 401K (for industry) or 403B (for schools and non-profits).  These types of accounts are like an Individual Retirement Account except that the limit on the money you can put into the account is by percentage of your income.  It’s currently approximately 15% of your income.  (There’s probably a hard limit on the total amount you can contribute as well, but I’ve never come close to that limit.)  Like the IRA, there are regular 401K accounts and Roth 401K accounts; and the same rules apply: regular 401Ks get taxed when the money gets pulled out, Roth 401K generate interest that is tax free (assuming it remains in the account until retirement).  These accounts are less flexible than the IRA accounts.  With IRA accounts, you can purchase almost anything to invest in (stocks, bonds, mutual funds, index funds, you can even purchase real estate or gold).  But with a 401K, you can only purchase from a select set of investments.  If you desire, you can “roll over” money from a 401K into an IRA.  This means that you can transfer the money from a 401K into an IRA.  Note that a regular 401K should be rolled into a traditional IRA and a Roth 401K should be rolled into a Roth IRA.

There are two benefits to 401K accounts:  (1) The real benefit of company retirement accounts are “matching.”  A company might provide a benefit of matching contributions you make up to a certain percentage (e.g. the company might contribute half of what you contribute into your 401K up to the first 4% of your contributions).  You really want to take advantage of that.  The second main benefit is (2) it allows you to contribute more to your retirement than the $6k cap permitted for IRAs.

My advice: if you’d like to contribute to your retirement (I highly recommend this), contribute as much as you can into your 401K to get all the matching from your company that they offer you.  After that, contribute to the more flexible IRA.  If you make the maximum contributions to your IRA, go back and make additional contributions to your 401K.

There is an additional, more sophisticated benefit of an IRA or a 401K.  If you’d like to borrow money, perhaps to purchase a house, then you can borrow that money from your retirement accounts.  You still have to pay interest to borrow that money, but that interest is paid into your own account.  You’re lending to and profiting from yourself!

So what stuff should you buy?  Everything up until now that I’ve told you about are facts that are either true or not (I think they’re true).  What I’m about to say now is my opinion, which means that it’s practically worthless.  Nevertheless, I’ll share it with you.

My approach has been to invest in a very diversified way and forget about it for long periods of time.  SPY, DIA, and SWTSX (Schwab Total Stock Market Index Fund) are great ways to do this.  Another investment that has worked well in the last few years is Nuveen Advantage California (NAC).  This is a mutual fund that invests in California municipal bonds with tax benefits.  For the past few years, it has yielded approximately 6% interest per year that is both state and federal tax free.  The danger with this investment are (1) if interest rates increase (which the Fed is currently expected to do) then the price of the bond will likely decrease and (2) that California Municipalities might go bankrupt (San Jose is currently almost bankrupt); if many municipalities go bankrupt then this investment will become worthless.  Mutual funds could also be considered: large cap mutual funds (invests in big companies), mid cap mutual funds (invests in medium sized companies), healthcare mutual funds, energy mutual funds, and others.   Conservative mutual funds help protect against volatility in the market; Fidelity Conservative Income Bond Fund is an example (FCONX).  FCONX purchases bonds issued by large institutions with excellent credit ratings (so you’re almost guaranteed to make money but you don’t make very much).  To protect against the real threat of inflation (which I think will result from the endless printing of money that Federal Reserve is doing) then you can purchase gold or GLD.  Finally, if you believe you have some insight into a specific company then you can purchase individual shares of that company.  For example, if you think Tesla will continue to do well, you might purchase shares in Tesla.

Having said all that, I have an additional thought.  Right now the stock market is at all time-highs and just going higher.  Everyone is talking about how much money that have in the stock market.  This is very reminiscent of 2008 when everyone was rejoicing about the amount of money that their house was worth.  I’d be very wary of investing a whole lot of money into the stock market right now.  I know very few people who are talking about bonds and gold.  In fact, the price of both bonds and gold are relatively low right now.  In general, I’d consider purchasing GLD and bonds (of institutions with great credit that can withstand a significant drop in the stock market) before investing in stocks.  Keep in mind that the future is anyone’s guess.

Many new investors are under the preconception that they must watch the stock market closely if they are investors.  Corresponding to the thoughts of this article, investing is a patient person’s game.  If you put money in, pretend it’s not there.  Every once in a while (e.g. every year or so when it’s time to contribute to your IRA again) look at your accounts and make any adjustments that you feel are beneficial.  Then forget about it again.  And keep an ear to the news to make sure things haven’t gone haywire in the mean time.

If you made it this far, I’d love to hear if this was helpful for you.

[1]  http://carlinlawgroup.com/media/SCVN%205-21-16.pdf