Brokerage Accounts obtained from a financial institution are required in order to purchase stocks, mutual funds, most
bond types, and other investments. Brokerage accounts generally require an initial deposit into a Cash-Management
Account of at least $1,000, or alternatively they may be linked to a regular bank checking account that has a cash balance.
Purchases are made from this account and dividends are paid into this account. Other types of accounts are available
for the more sophisticated investor including Margin Accounts, which allow an investor to buy securities with money borrowed
from the broker, and Discretionary Accounts, which permit the broker to buy and sell shares for the investor without first
obtaining the investor's approval.
Types of Funds
The major investment types are stocks, bonds, mutual funds and hedge funds. Mutual Funds are collections
of different stocks and bonds that are managed by professional money managers. They are sold as shares based on market
price, the same way that stocks are bought and sold. While there is no legal definition of mutual fund, the term
is most commonly applied only to those collective investment schemes that are regulated, available to the general public and
open-ended in nature. Mutual funds are classified by their principal investments. The four largest categories
of funds are money market funds, fixed income (bond) funds, equity (stock) funds and hybrid funds. Mutual funds can
be either actively managed or based on the performance of a market index (an index fund).
There are three types of U.S.
mutual funds: open-end, unit investment trust, and closed-end. The most common type, the open-end mutual fund, must
be willing to buy back its shares from its investors at the end of every business day. Investors in a mutual fund pay
the fund’s expenses. Mutual funds pass taxable income on to their investors annually in the form in which it is
earned. For example, mutual fund distributions of dividend income are reported as dividend income by the investor. Net
losses incurred by a mutual fund are not distributed or passed through to fund investors.
Mutual funds have the following advantages compared to direct investing in individual securities:
Professional investment management
to participate in investments that may be available only to larger investors
Service and convenience
Ease of comparison
Mutual funds have disadvantages as well, which include:
- Less control over timing of recognition of gains
- Less predictable income
opportunity to customize
Exchange-Traded Funds (EFTs) are open-end or unit investment trust mutual funds that trade on an exchange.
EFTs track an index, a commodity or a group of assets like an index fund, but trade like a stock on an exchange. ETFs experience
price changes throughout the day as they are bought and sold, and unlike stocks their supply is limitless. The largest issuer
of EFTs in the US and globally is iShares. IShares are a family of ETFs managed by BlackRock. Each iShares fund tracks a bond
or stock market index.
Hedge Funds are an aggressively managed portfolio of investments that use advanced investment strategies such
as leveraged, long, short and derivative positions in both domestic and international markets with the goal of generating
high returns. While they are another type of commingled investment scheme, they are not considered a type of mutual fund,
are not governed by the Investment Company Act of 1940, and are not required to register with the Securities and Exchange
Commission. Legally, hedge funds are most often set up as private investment partnerships that are open to a limited number
of investors and require a very large initial minimum investment. Investments in hedge funds are illiquid as they often require
investors keep their money in the fund for at least one year.
Self-Managed Investment Accounts
Depending upon your personal situation you can elect to manage your investments yourself or work with a professional
investment broker. If you have basic knowledge of the tools and techniques of investing, have the time and ability
to manage your own diversified portfolio, and are able to stick to a sound investment strategy, then you may decide to do
your own investing. To quote Warren Buffett “To invest successfully over a lifetime does not require a stratospheric
IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making
decisions and the ability to keep emotions from corroding that framework”. If you are new to investing, you may
wish to start with reading the “bible” on investing titled “The Intelligent Investor”, written by
Benjamin Graham in 1950 and first read by Warren Buffett when he was nineteen.
Intelligent Investing: Jason Zweig, who edited the revised edition of Benjamin Graham’s
book, commented that Graham’s core principles on investing (summarized below) are as valid today as they were during
- A stock is not just a ticker symbol or an electronic blip; it is an ownership interest in an actual
business, with an underlying value that does not depend on its share price.
- The market is a pendulum that forever
swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap).
The intelligent investor is a realist who sells to optimists and buys from pessimists.
- The future value of every investment
is a function of its present price. The higher the price you pay, the lower your return will be.
- No matter how
careful you are, the one risk no investor can ever eliminate is the risk of being wrong. Only by insisting on what Graham
called the “margin of safety” – a never overpaying, no matter how exciting an investment seems to be –
can you minimize your odds of error.
- The secret to your financial success is yourself. If you become a critical
thinker who takes no Wall Street “fact” on faith, and you invest with patient confidence, you can take steady
advantage of even the worst bear markets. By developing your discipline and courage, you can refuse to let other people’s
mood swings govern your financial destiny. In the end, how your investments behave is much less important than how you
As mentioned earlier, securities (stocks, mutual funds, etc.) are purchased and sold through a brokerage account.
In order to initiate a trade, you must specify the 1) type of trade, 2) price and 3) terms.
Type of Trade. The trade can be a Buy, Sell, Sell Short or Buy to Cover. A Sell Short
is used to sell a security that you don't own -- you are agreeing to borrow shares and sell them, thereby obliging yourself
to purchasing and repaying the borrowed shares at a later date. You purchase these pay-back shares via a Buy to
Cover. A Sell Short is used when the price of a security is expected to decrease. It generally costs more
and is risky in that it commits you to a future trade that could cause you to lose money.
2. Price. You can buy or sell a security at Market Price
(the best price available at the time that the order is executed) or specify limits on the unit price that you're willing
to pay or receive for the security. A Limit Order is an order to buy a security at a price less than
current market or sell at a price higher than current market. Other, more complex orders can be placed including a Stop Loss
Order which is placed below the current trading price to limit losses on holdings if the price declines. Finally,
you can place a Trailing Stop Order, which is similar to the Stop Loss Order, but protects a profit, as opposed to protecting
against a loss.
3. Terms. The order can be a Day Order, Good
Until Canceled (GTC) or All or None (AON). A Day Order automatically expires if it is not executed during the day's
trading session. A GTC order is an order to buy or sell which remains in effect until it is either executed or canceled.
A AON order prevents a broker from filling a large order in smaller blocks and at significantly different prices.
Professionally-Managed Investment Accounts
A Professionally-Managed Investment Account is managed by a professional money manager and is tailored to the individual
investor based on his short and long term objectives and risk tolerance. Generally the money manager starts with a review
of the investor’s assets, liabilities, income and expenses. From this information and the investor’s age,
marital status, family obligations (home, education, etc.) and retirement goals, the money manager can determine the best
strategy for meeting the investor’s goals.
Money managers invest in diversified portfolios of stocks, bonds and
other instruments. The two major investment strategies of money managers are to 1) invest directly in stock comprising
the various asset classes or to 2) invest in mutual funds that target the asset classes. I personally believe that the
second strategy is a safer and better way of achieving long term growth. By selecting a combination of highly rated
actively managed mutual funds and index funds, this strategy brings together the collective experience of many highly-rated
mutual fund managers combined with the low-cost market tracking performance of index funds. This approach allows under-performing
funds and fund managers to be replaced as needed to assure the investor of maximum growth and safety.
Traditional or Discount Brokerage Firms
For self-managed accounts, you may wish to consider a discount brokerage firm. A discount firm will enable you
to buy and sell investments on your own through their website and provide you analytical tools to make informed decisions.
They charge reduced fees for their services.
With a traditional firm you may be required to interact directly with
a broker who will provide investment advice and execute your buy/sell orders. In this traditional full-service account,
you can pay a broker to manage your investments. For this service they will charge a percentage (typically 1% to
3% annually) of your total investment portfolio, with the percentage charged decreasing as the total value of your
managed assets increases. Some investment firms offer you the choice of either traditional or discounted services.
firms can differ in terms of:
- Website quality/functionality,
- Analysis tools,
- Scope of tradable
- Order execution speed,
- Optional features/services,
- Relationship account linkage/fees,
extent to which investors can trade on margin, and
Fees can be charged for buy/sell orders, account
management, inactive accounts, closing accounts, and for incidental items. Consequently, the brokerage firm that's right
for you is the one that best meets your needs and provides a quality service at the best price. Don't lose sight
of the fact that your only purpose of a having a brokerage account is to make the most money safely and quickly.
To maximize portfolio safety and performance, your investment assets should be spread across various classes of investment
products. In the broadest sense these include cash, equities (stocks), fixed income (bonds), and other. Equities
generally include large cap, mid-cap, small cap and international stocks. The fixed income class generally includes
government bonds, corporate bonds, international bonds, emerging market bonds and mortgage-backed bonds. “Other”
typically includes real estate, commodities (e.g. oil), precious metals (e.g. gold) and futures.
The percentage of your total portfolio invested in each asset class depends on the amount of risk versus growth that
you’re willing to take. An aggressive portfolio is weighted more heavily towards stocks, and a conservative portfolio
is more heavily weighted towards bonds. As you get closer to retirement, you have fewer years to recover from a possible
down market, and therefore should begin pursuing a more conservative portfolio. Following is a possible approach for
your asset allocation:
Years to Retirement
| U.S. Stocks (%)|
| Non-U.S. Stocks (%)|
| Bonds (%)|
Stock funds (mutual or index) or Bond funds that you purchase combine assets into various categories as follows:
- Large-cap – Owns shares of firms with stock market values, or market capitalizations, of $10 billion or more.
& Mid-cap – Owns smaller companies.
- Foreign – Owns shares of non-US companies.
- Specialty –
Owns assets that don’t move in sync with the broad stock or bond market.
- Target date – Provides exposure
to a mix of stocks and bonds appropriate for your age.
- Balanced – Offers exposure to a fixed mix of stocks and
- Value – Owns stocks that are selling at bargain prices.
- Growth – Focuses on companies with
- Blend – Owns both growth and value-oriented stocks.
- Short-term – Owns bonds that mature in about two years or less.
- Intermediate-term – Owns bonds
that mature in 2 to 10 years.
- Multi sector – Owns a variety of different types of bonds, foreign or domestic.
- Inflation protected – Owns bonds whose value at least keeps pace with the consumer price index.
Qualified and Non-Qualified Accounts
Qualified Investment Accounts qualify for special tax treatment meaning that their income and growth are not taxed
until money is withdrawn (generally in retirement). Qualified Accounts consist of pre-tax dollars invested in traditional
IRAs, 401(k)s, etc. Because of this tax treatment, you may wish to keep investment products that produce and report
income (e.g. mutual funds) inside qualified accounts. This way you are not taxed on the “reported” (real
or otherwise) income until you begin withdrawing funds at some future date. By the same logic, it is advantageous to
invest in individual stocks in your non-qualified (after-tax) brokerage account. These stock ownership investments produce
regular predictable real income that is taxed at the capital gains rate.
Dividend Income: No brokerage account discussion is complete without mentioning the advantage
of holding stocks of quality profitable companies that have a track-record of generating dividends and increase their dividend
yield annually. This is a great hedge against inflation, particularly in retirement when much of your other income (pensions,
annuities, etc.) is fixed. Every investment strategy should include the regular purchase and accumulation of individual