What’s The Difference Between A Stock And A Bond?
This poses an interesting question because it highlights how many people really have no idea about the different type of investment “vehicles”, as they are often called.
*You know what “equity” is, right?
Especially if you own a home, it’s the difference between what you owe and what you own. If you have a $300,000 house and you owe $200,000, then you have $100,000 in equity, or ownership.
Stocks are much the same thing, except that what you own is (typically) a VERY small piece of a major company. In most cases, you’ve already paid for it in full, and therefore you own it outright with no debt. (It is possible to borrow ownership, but that’s a level 200 course).
This is why stocks are often called equities, and vice versa. Think of yourself as a part owner, you can attend the annual meetings and vote on issues as requested by the board of directors – using what are known as “proxy statements”.
You will probably have a very limited impact on the direction of the company unless you own 5% or more of the outstanding stock, what most people buy stocks for is to either a) participate in the growth of the stock price or b) get paid cash dividends as a reward for owning the stock.
In an ideal situation, both will happen, at which point you have to be clear on why you own the stock – is it for the growth, in which case you might want to sell it for a profit – or is it for the dividend (read: the cash flow) in which case you might not want to sell it.
A bond, on the other hand, has NOTHING to do with ownership. A bond is like your mortgage loan or your car or other loan. It is an agreement between you and another party by which the lender gets paid a fixed amount of interest for a fixed period of time. The cool part is that YOU are the lender. YOU are the bank! These are generally not as exciting as stocks, but that can be a good thing! Being the lender instead of the borrower can be a very positive and eye-opening experience!
So, what is a mutual fund then? Fortunately this is easy. A mutual fund is a basket of various stocks, or a basket of various bonds, or in some cases, both. Which of those 3 general approaches, and which specific investments are held by the mutual fund are defined by the fund’s prospectus, which states what their objective is, and what they can and cannot do, so that other people can hold them accountable for doing what they say they will.
Mutual funds are often a little more expensive than individual stocks and bonds, simply because you’re dividing your money among many different investments, a form of diversification, rather than having everything in one basket.
Further questions?
Email me at: John@financialideasblog.com
or go to http://www.whattoinvestinnow.com
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