Everything You Need to Know About Investments- Part 1

You’ve found the deal. Now you need to raise capital…

However, in order to raise capital from wealthy individuals and/or institutions, you first need to understand what you’re up against.

Pro tip: Go about it as if you are the investor. Try putting yourself in their shoes!

As a high net worth individual, what can I do with my money? I want to invest it in things that will give me a highest rate of return – right?!

Well, let’s first talk through the different options that are out there. I’m here to help you guys understand the different types of PUBLIC investment options.

Risk-free Rate- Aka: US Government Bonds

Everything in finance is bench-marked against the risk-free rate. The risk-free rate is just what it sounds like – a place you can invest your money with essentially ZERO risk. 

The risk-free rate is money that is guaranteed by the U.S. Government. The U.S. Government is respected and recognized as the safest and most highly protected place in the world to invest your money.

A bond is an agreement between two or more parties.

The Government will issue a bond – typically for $1,000. You give them $1,000 today and they will give you back your $1,000- plus interest in the future. 

The Federal Reserve sets a target rate – but official rates are posted daily for the 1 month, 2 month, 3 month, 6 month, 1 year, 2 year, 3 year, 5 year, 7 year, 10 year, 20 year, and 30 year treasury rates. 

You throw those points on a graph and that gives you the yield curve. The yield curve is a demonstration of how the federal reserve and the market as a whole feel about the future. 

The risk free rate that comes from the government will have some of the LOWEST returns compared to ANY other investment. That’s where the phrase, “Higher Risk = Higher Return” comes into play.

Mortgage Backed Securities (MBS) / Asset Backed Securities (ABS)

One step up from Government Bonds are securities that have an asset tied to its value.

These are perceived as the 2nd safest asset you can invest in – why? Because there is an underlying asset tied to the value of the investment.

If Gov Bonds are 1%, then these will be anywhere between 1% – 2.5% in terms of annual rate of return. In other words – MBS and ABS will offer slightly better returns than the risk-free rate.

However, MBS and ABS have a rocky history…

Back in the mid 2000’s, brokers packaged a bunch of these lower quality investments together and called them a “diversified investment” and then kept creating new products out of the same asset to make more money. 

Lenders were handing out money to anyone and everyone (also known as sub-prime loans), which created an artificial bubble that eventually popped – resulting in the historical Financial Crisis of ‘08. 

MBS are better today– sort of. Bond rating agencies have stepped up their game… but only slightly.

They do have higher yields than U.S. Bonds – However, If you want a safer investment – go back to Government Bonds! 

Municipal & Corporate Bonds/Fixed Income

So the next investment up from an MBS, is either a Municipal or Corporate bond.

Municipal Bonds are issued by cities. They are usually tax-free and have an annual return rate 1.5%-5.0%- depending on the project.

Not too bad, huh?

In contrast, Corporate Bonds are from companies. The return on Corporate Bonds can vary drastically because it is entirely dependent on that companies current cash flows.

Corporate Bonds with extremely high yields are also referred to as Junk Bonds… because their is a high likelihood of default.

Stock/Equity Markets

The stock market is another ring up on the investment ladder in terms of both risk and return from the bond market.

In the stock market – you are now purchasing equity into the company – instead of giving the company a loan in the bond market. 

Just as there are both “safe & risky” bonds – there are (relatively) “safe & risky” stocks. 

You can lose a lot of money in the stock market. But you can also make a lot of money – which is why it is becoming more and more popular.

You can buy “blue chip stocks”, also referred to as ‘value stocks’ stable companies like Johnson & Johnson or Walmart. Or you can buy growth stocks like Tesla. 

You can buy stock in small companies or large companies, Foreign Emerging Markets, or Foreign Developed Markets. 

The options are pretty much endless!

Most people will buy stocks where they anticipate the best return for the least amount of risk. 

Investors create a “diversified portfolio” of investments to mitigate their risk and disperse their investments across different industries, markets, or countries. 

The Holy Grail in the Stock market is known as the S&P 500. The S&P 500 is an aggregation of the top 500 US companies with the largest market capitalization. 

The average historical return of the S&P 500 since inception in 1926 is 10-11%. When you introduce compound interest… that can add up fast.

That 10% – 11% is what you’re trying to beat. Everyone compares themselves to the S&P – every financial adviser will hold to the S&P 500 as their benchmark.

So why don’t you just buy the S&P 500?

That’s what Warren Buffet, the greatest investor of all time, tells everyone to do.

But why don’t people do it? Because they think they are smarter than that. Some of them are – but most aren’t. Only 15 of 200 mutual fund managers beat the S&P 500 over time.

The other 93% FAIL. They still make you money…. but not as much if you had just invested in the S&P 500.

Before you go…

Now that you have a better grasp on Public Investments, next time, we’ll let you in the loop on private investments.

But until then, if you have any questions about raising capital or investing, feel free to join my one-hour free training- by signing up here.

Thanks for the read!

Bridger Pennington

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