You’ve heard about stocks, bonds, and mutual funds. Perhaps, however, you aren’t up to speed on what distinguishes these investment vehicles.
Don’t stress! We’ve got a beginner’s guide to all things stocks, bonds, and mutual funds to fuel your interest. Keep reading and we’ll help you make savvy investment choices down the road.
What are stocks?
When you purchase a stock, you effectively buy a tiny piece of whichever company sold the stock. Typically, a company issues a stock offering in order to raise money to fund new projects or expand their operation.
What are the perks of owning stock? First, you own a percentage of the overall value of the company. Second, certain companies pay dividends to their shareholders.
To buy stocks, you’ll need to open an account with a brokerage firm. Online discount brokerages, such as Robinhood, are all the rage these days. They’re easy to use and don’t charge the exorbitant fees associated with full service brokerages.
Types of stocks
There are two primary types of stocks: common and preferred. Common stocks are the most widely traded. They entitle shareholders to voting rights, while preferred stocks offer higher dividend payments.
Voting rights grant shareholders the ability to influence certain company decisions, like appointing new board members or approving mergers and acquisitions.
Pros & cons of stocks
The major downside to stock market investing is that there is inherent risk involved. Stock prices 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. Pulling your money out of the market in a recession is usually the opposite of what you want to do.
What are bonds?
Bonds are IOUs that companies, governments, or other entities sell as a way to raise money. When you buy a bond, you’re basically lending money to whomever sold it. Of course, you get some benefits for doing this.
Most bond agreements also include interest payments. The issuing entity pays these at regular intervals to anyone who bought a bond from them. So, bonds tend to be relatively safe investment vehicles that also offer a minor but guaranteed income stream.
Interest income from bonds is unlikely to amount to much. 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%. This 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:
Bond funds offer the benefits of professional management, diversification, and liquidity. This is because you buy and sell them on exchanges similar to stocks.
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:
What are mutual funds?
Mutual funds pool the money of multiple investors to purchase a diversified portfolio of stocks, bonds, or other assets. A professional fund manager oversees the investing. They make decisions about which assets to buy or sell based on the fund’s investment objectives and strategy.
Mutual funds offer several advantages and disadvantages. Before we get to that, let’s cover the different types of mutual funds you’re likely to encounter.
Types of mutual funds
Pros & cons of mutual funds
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. They’re generally easy to buy and sell quickly if you need to liquidate assets.
In the long term, a well-diversified stock portfolio should appreciate at about 10% annually. This 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. You also get regular coupon payments (usually every six months) based on a variable interest rate.
Widely considered the safest types of investments, don’t expect higher returns like with stocks. As of this writing, a US government I Bond offers a 4.3% interest rate. This is much lower than the 10% you could expect long-term from a diversified stock portfolio.
Mutual funds allow many low-level investors to pool their resources and invest in a mutual fund with specified investment goals. Then, a mutual fund manager makes decisions about how to invest based on those goals.
Mutual funds tend to be safer investments 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. Money market funds, however, are often 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. Government bonds are especially safe, as government credit tends to be quite good.
What is the downside of a mutual fund?
A mutual fund, though relatively safe, does come with some downsides. High fees tend to be the most relevant issue. There are a couple other reasons you may not want to invest in a mutual fund, however.
Tax inefficiencies are another big one. You cannot control disbursements from mutual funds. As a result, 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.