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Paper assets such as stocks, bonds, and notes are assets that only exist on paper or, these days, on a computer screen. They generally represent ownership in something, like a company, or a right to something, like principal and interest payments. So while the only visual evidence of your asset is a mere piece of paper or code, what what you've actually bought is obviously much more than that. Make sense? Then let's go!
Paper Assets: The Basics
- Ease of Entry: Easy. Go to any brokerage firm’s website (I recommend TradeKing because they have the lowest commissions at $4.95 a trade), open up an account, and you can start buying paper assets today.
- Money Requirement: Low. You can go to TradeKing right now with a few bucks. They have no account minimums.
- Time Requirement: Low. If you have an hour or two of time right now, you can start investing in paper assets.
- Potential Payoff (cash flow): Low. Apart from certain investments (such as REITs), dividend yields in companies that you want to invest in typically won’t cross 4% per year, and bond yields are even less (but safer).
- Potential Payoff (appreciation): High. And note the keyword “potential” here. Yes, in theory, you can buy a stock, and five years from now, it could be worth five times as much. But no one can predict the future.
Although there are countless types of paper assets with varying degrees of complexity and entry requirements (some investments require that you be an accredited investor), we’ll only talk about the three most basic paper assets here that are accessible to most everybody reading this, stocks, bonds, and notes..
Stocks represent an equity stake in a company. The source of cash flow in a stock investment is called a dividend, or a certain amount of money that a company periodically pays out to its shareholders out of its profits. Established companies in steady industries such as energy, consumer staples, and utilities tend to pay decent dividend yields (>3% in the current market) with relatively low risk.
Coca-Cola Co., Procter & Gamble, General Electric, Boeing, and Chevron are all companies that boast a dividend yield of greater than 3% as of close of market today (2/10/17). These companies have been around for decades and are not looking to grow by leaps and bounds in the near future. They are looking to maintain their market share and provide stability for their shareholders.
Some stocks, of course, do not pay dividends. This is typically true of younger companies and those in sectors, notably tech, that are more focused on reinvesting earnings back in the company rather than paying them out to investors as dividend. As of today, Amazon, Facebook, and Google, all do not pay dividends. These kinds of companies are all about growth — and fast growth at that, which translates to rapidly-appreciating stock prices, because that’s what shareholders want to get out of investing in these companies. So instead of paying out cash from their earnings to their shareholders, who are typically more interested in appreciation than cash flow, these companies invest all of their profits back into themselves to fund more research, projects, purchases, etc., which all translate to more growth. So these companies appeal more to investors who are looking for rapid growth and appreciation potential rather than a stable, cash-flowing investment.
Of course, many companies in this second category happen to be high-flying tech companies. But this doesn’t mean that technology companies as rule don’t pay out dividends. IBM pays a dividend, but of course IBM is a much more mature company than say Google or certainly Facebook. Apple pays a dividend as well, but of course it does have something like $160 billion in cash as of the end of last year, so it has a little more leeway and can afford to pay out a bit of its profits every quarter while still plowing a lot of cash into research and development.
So which is better? That's all up to you.
Bonds represent a creditor stake in a company or government. Here’s how it works: companies and governments need money, which is typically called “capital” in this context, to grow or provide more programs, respectively. Companies raise most of this capital from profits and issuing stocks (see above), and governments do so by imposing taxes on their citizens, but oftentimes these entities decide to borrow money instead.
Of course, companies can go out and borrow from banks, and governments can go out and borrow from other governments, but another useful way for these entities to obtain access to cash is by issuing bonds, which are, for all intents and purposes, mini-loans that investors can purchase and on which they receive interest payments at a certain yield.
And unlike dividends, this yield is fixed. Company did really well this quarter? You still get the same interest payment. Company did horribly this quarter? You still get the same interest payment. Company went bankrupt? You'll get paid before the shareholders. So bonds are seen generally as a much more predictable and stable asset class than stocks.
Notes are similar to bonds in that they involve debt, but at least for our purposes, they involve you lending money to individual people rather than corporations or governments. And, of course, these people you lend money to will pay you back with interest.
The two kinds of note investing that I like are 1) notes secured by real property and 2) peer-to-peer lending notes. I'll reserve real estate notes for another time since these are typically more capital-intensive and require much more due diligence, but I'll tell you a bit about peer-to-peer lending platforms now.
What is peer-to-peer (or P2P) lending? It's when potential lenders (investors) and potential borrowers get together on an online platform, and the lenders lend money to the borrowers. Sounds simple enough, right? Well, it is! And the great thing about it is that you as a potential lender don't have to lend all of your money to one borrower. That would be extremely risky. On the leading P2P lending platforms, you can invest as little as $25 in a note!
And who the heck borrows only $25 on a P2P lending platform? No one! See, your $25 would be combined with 1,000 other people to lend $25,000 to a borrower on the platform, and in this way all of you investors have spread out your risk. Instead of one investor lending $25,000 to this borrower, 1,000 investors are lending $25 each to this investor. If the borrower doesn't pay (the word for this is “defaults”), then you're out $25 rather than $25,000. Win-win!
Putting It All Together
So which is best? Stocks, bonds, or notes? The answer is all of them! They all have different pros and cons. Stocks are more risky, but over the long run, you'll probably enjoy the highest return on them in terms of both cash flow and appreciation. Debt investments, such as bonds and notes, are typically less risky (assuming the borrower has a decent credit rating/score) and provide stable cash flow now, but they won't go up in value like stocks.
I would encourage my readers to set up both a brokerage account and a P2P lending account just to get experience. Be on the lookout for my monthly updates on exactly what I'm investing in and what kind of returns I'm getting. 🙂
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