Investing your money is an essential part of personal finance, and yet many people do not understand the difference between investment vehicles. This article’s purpose is to underline the main differences between a few simple investment vehicles; stocks, bonds and mutual funds.
Stocks are issued when a business is incorporated, essentially, a share of a company’s stock is a portion of the company’s ownership. Stocks can be publicly traded, available in the stock market, or privately issued to investors. Publicly traded stocks rise in value essentially due to the sentiment of traders regarding the corporation. The opposite is also true. Certain stocks pay dividends, which are payments to shareholders proportionate to their number of owned shares. For instance, XYZ’s stock is valued at $100, and John purchases 10 shares, totaling $1,000. A year later, XYZ has grown substantially, and the demand for stock has increased as traders value the company higher and believe that it is a sound investment. Buyers offer $200 per share, and John sells his shares, totaling $2,000 or $1,000 of profit. John no longer owns a portion of XYZ since he sold his shares.
Stocks can carry varying levels of risk, smaller, newer companies tend to carry more potential growth and loss than bigger, more established “blue chip” companies. However, no stock investment is safe, no matter the size of the company.
Bonds are essentially IOU’s issued by a company or a government. They are a type of loan providing, in most cases, a fixed income to the lender. Simply put, a bond is similar to a credit line, or mortgage. Interest is paid to the bond buyer as if it were a regular loan. Bonds, therefore, in general, represent much less risk than stocks. Some bonds are publicly traded whereas others are sold over the counter. Bond investments are nevertheless not entirely secure investments.
Mutual funds are, in essence, portfolios of stocks, bonds, or other assets managed by a professional fund manager. These can often provide greater returns than bonds at a lower risk than stocks. However, as with bonds and stocks, investments are never 100% secure. The main advantage of mutual funds is that, instead of having to personally diversify to increase security, an investor can simply invest with a mutual fund which does the diversification for them. The downside is that the actual investors do not control the investment decisions, as well as mutual fund management fees which can substantially cut into potential profits for investors.
In essence, these assets sorted by ascending order of risk and potential reward are: Bonds, mutual funds and stocks. It is important to note that there are other investments and any and all investment decisions should be made rationally and logically, I am not providing any investment advice whatsoever, simply explaining a minority of popular investment vehicles.
Dear reader, I urge you to learn more about investing your money to increase your potential income.
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Rich Dad Poor Dad: What the Rich Teach Their Kids About Money That the Poor and Middle Class Do Not!
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The 10X Rule: The Only Difference Between Success and Failure