You’re a responsible adult with expendable income and it’s time for you to start thinking about investing to secure your future. You’ve heard about stocks, bonds, and mutual funds, but perhaps you aren’t totally up to speed on what, exactly, distinguishes these investment vehicles.
Well time to celebrate, because we’ve got a beginner’s guide to all things stocks, bonds, and mutual funds to fuel your interest and help you make savvy investment choices down the road.
When you purchase a stock, you effectively buy a tiny piece of whichever company sold the stock. But why would a company sell itself off in tiny bits to thousands of different owners? Typically, a company issues a stock offering in order to raise money, either to fund new projects or perhaps expand their operation.
What are the perks of owning stock? In addition to owning a percentage of the overall value of the company (which you could then sell to someone else someday, ideally for a profit), certain companies pay dividends to their shareholders, which are payouts of a portion of the company’s profits.
The amount of a dividend payment depends on the company’s dividend policy and its profitability. Some companies may have a consistent dividend payment, while others may pay dividends only when they achieve certain financial milestones or have excess cash. Dividends can be paid in cash or additional shares of stock. The frequency of dividend payments also varies but is usually on a quarterly basis.
As far as how much it will cost you to become a shareholder, that’s going to vary WILDLY depending on which companies you want to invest in. A single share of Apple stock runs about $174 (as of the writing of this article anyways — stock prices rise and fall more often than the tides, but much, much less predictably), whereas you could buy over 900 individual shares of Bed Bath and Beyond for the same price (quick note: you probably shouldn’t).
To buy stocks, you’ll need to open an account with a brokerage firm, which can be either an online discount brokerage or a full-service brokerage. Online discount brokerages, such as Robinhood, are all the rage these days because they’re easy to use and don’t charge the exorbitant fees associated with full service brokerages (plus they have flashy, attractive apps with colorful graphs and exciting buttons). With an online brokerage account, you can basically buy stocks in the same way that you order food on UberEats: with a tap of your finger.
Full-service brokerages, like Morgan Stanley or Merrill Lynch, offer more personalized services and advice but usually charge higher fees. Once you’ve opened an account, however, it’s like having a stock-buying butler you can order around: simply ask your broker to execute an order for you (which is a fancy way of saying you tell them which stocks to buy) and they do it.
Of course, it’s essential to research and analyze the individual stocks that you’re interested in before making any purchases so you don’t end up buying into a company that, for example, just went bankrupt (looking at you, Bed Bath and Beyond). That’s one nice thing about paying for a full service brokerage: they can recommend stocks based on your risk tolerance as well as your ethics (for example, investing only in companies that offset their carbon emissions).
Types of stocks
There are two primary types of stocks: common and preferred. Common stocks are the most widely traded and entitle shareholders to voting rights, while preferred stocks offer higher dividend payments but typically do not include voting rights. Voting rights grant shareholders the ability to influence certain company decisions by participating in shareholder meetings and voting on important issues, such as the appointment of board members or approval of significant corporate transactions like mergers and acquisitions.
When you own common stocks, you are granted voting rights proportional to the number of shares you hold. Typically, one share equates to one vote, but this can vary depending on the company’s structure and policies. As a general rule, the more shares you own, the more influence you have over the company’s decision-making process.
Don’t get too excited though. If you’re hoping to enact some The Dark Knight-style corporate takeover, in all likelihood you’re going to need Bruce Wayne money to do it. Sadly, for most entry-level investors, the ability to participate in shareholder meetings is going to be about as meaningful as voting for the Green party in a presidential election.
Given everything we just said about how much your single-stock-vote is going to matter at Apple’s next shareholder meeting, you might be more interested in preferred stocks. When you buy preferred stocks, you sacrifice your voting rights in favor of higher dividend payments and priority over the common stockholders in the event of the company going bankrupt or having to liquidate its stocks.
So, unless you have a legitimate opportunity to own a significant portion of a company and impact its decision making, preferred stocks are probably the way to go.
Pros & cons of stocks
Overall, there are some attractive aspects of purchasing stocks, and ones that may make you choose a different investment vehicle for your hard-earned money:
Just keep in mind that dividend payouts tend to hover between 3 and 5% of your investment, so if you want that income to be meaningful, you’ll have to invest a lot.
Just remember that the weight of your vote is proportional to your investment in the company, so unless you a measurable amount of a company, your vote is about as impactful as tossing a shot glass of water onto a forest fire.
For example, Apple has about 16 billion individual shares in circulation as of 2023, so you would need to buy 160 million shares to have a 1% stake in the company (which will cost you just shy of $28 billion).
The major downside to stock market investing is that there is inherent risk involved. Stock prices ebb and flow; they rise and fall like the tides of some vast and incomprehensible ocean. That means, in the short term, market volatility could wash away your investments faster than a sand castle in a hurricane.
It’s worth noting, however, that well-diversified investments tend to appreciate in the long term, and so pulling your money out of the market in a recession is actually the opposite of what you want to do.
(Stock brokers are fond of saying that their industry is the only one where, when there’s a huge sale, nobody wants to buy anything.)
Bonds are IOUs that companies, governments, or other entities sell as a way to raise money. So, basically, when you buy a bond, you’re lending money to whomever sold it with the promise that they’ll pay you back at a specified future date.
Most bond agreements also include interest payments, which the issuing entity pays out at regular intervals (usually every six months) to anyone who bought a bond from them. So, bonds are considered a relatively safe investment vehicle that also offers a minor but guaranteed income stream.
It’s worth emphasizing that word “minor.” Interest income from bonds is unlikely to amount to much, as bond interest rates tend to be much lower than, for example, expected annual growth from a stock investment. As of 2023, federal government-issued bonds had an interest rate of 4.3%, which means a $10,000 investment would earn you a whopping $430 per year.
If you still want to invest in bonds, there are a few ways to do so:
Types of bonds
There are various types of bonds, each with its own risk and return characteristics:
Pros & cons of bonds
Pros of Investing in Bonds:
Cons of Investing in Bonds:
Mutual funds are investment vehicles that pool the money of multiple investors to purchase a diversified portfolio of stocks, bonds, or other assets. A professional fund manager oversees the mutual fund investing itself, making decisions about which assets to buy or sell based on the fund’s investment objectives and strategy.
Mutual funds offer several advantages and disadvantages, but before we get to that let’s cover the different types of mutual funds you’re likely to encounter.
Types of mutual funds
There are various asset classes of mutual funds, each with its own investment objectives and strategies:
Pros & cons of mutual funds
We get it, you don’t have time to read all the beautiful, flowery language we wrote about the distinctions between stocks, bonds, and mutual funds. Here’s the gist of it:
Stocks are the highest-risk, highest-reward investment option out of the three. They represent a tiny piece of ownership of the company who sold the stock, and are generally easy to buy and sell quickly if you need to liquidate assets.
In the long term, a well-diversified stock portfolio is expected to appreciate at about 10% annually, which far outpaces bonds and mutual funds’ expected growth.
Bonds are IOUs sold by governments, corporations, or municipalities. They offer an allegedly guaranteed return on investment, plus regular coupon payments (usually every six months) based on a variable interest rate.
Widely considered the safest investment option, the expected return on bonds is much lower than that of stocks. As of this writing, a US government I Bond offers a 4.3% interest rate, which is much lower than the 10% you could expect long-term from a diversified stock portfolio.
In the investment world, mutual funds are the equivalent of those schools of thousands of tiny fish that all group together to appear to be a huge and intimidating fish.
Basically, a lot of low-level investors pool their resources to invest in a mutual fund, which has specified investment goals. Then, a mutual fund manager makes decisions about how to invest based on those goals.
Mutual funds tend to be relatively low-risk and have a low bar to entry in terms of investable capital. You do, however, end up paying management fees to your mutual fund manager, which reduces your overall return on investment.
Which is better, stocks, bonds, or mutual funds?
Depends on what you’re looking for. If you want the highest possible return on investment, stocks are the way to go. If you want the safest possible home for your money, government-issued bonds are probably the way to go. Mutual funds tend to fall somewhere in the middle, though money market funds, a type of mutual fund, is often considered to be the safest investment overall.
Are mutual funds safer than stocks and bonds?
A mutual fund is going to, overall, be safer than any individual stock, as it’s inherently diversified. Bonds, on the other hand, can be a safer home for your money than a mutual fund because they’re backed by the credit of the issuer, who is often a government entity with excellent credit.
What is the downside of a mutual fund?
A mutual fund, though relatively safe, does come with some downsides. High fees tends to be the most relevant issue, however there are a couple other reasons you may not want to invest in a mutual fund.
Tax inefficiencies is another big one: you cannot control disbursements from mutual funds, and so you may have unpredictable tax events that cost you more money than they make you come tax season.
What is the safest type of mutual fund?
Money market funds are the safest type of mutual fund, generally speaking. As a result, they also have the lowest return on investment.
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