Investing is an incredibly important aspect of life that can help people of all ages accomplish a variety of things- whether it be saving for a rainy day, building a nest egg to finance an important purchase like a car or home; or ensuring that you have enough money for your retirement years. On a daily basis, we see terms like stocks and bonds used, but not many people are fully aware of what they mean, or how they work. Our Personal Financial Management blog series will help you by introducing you to the basics of investing; before progressing to more complex topics in personal finance in the weeks ahead.
Stocks are units of ownership in a company. If you purchase stocks, you are purchasing a share of ownership in a company. This is also referred to as equity ownership. In purchasing stock, you as the investor hope that the price of your shares will increase if the company performs well (or if you are short-selling (or “shorting”) a stock, you are betting the price will decrease- but for simplicity- today we will just focus on regular purchasing of stock- or “going long”). Stocks are traded on exchanges that bring buyers and sellers together to facilitate transactions- some examples of exchanges include the NASDAQ and NYSE in the United States, and the TSX (Toronto Stock Exchange) here in Canada.
Investing in stocks is considered risky- as there are no guarantees the value of your investment will increase. The company you are investing in could go bankrupt, or a host of other factors could occur that could drive down share prices- including external economic events and global disasters, such as Covid-19- which has wiped out $16 trillion in global stock market value in the span of just one month! (https://www.cbsnews.com/news/coronavirus-has-cost-global-stock-markets-16-trillion-in-less-than-a-month-2020-03-12/)
Bonds are debt securities that can be issued by either private corporations or public government entities. In the case of government bonds- think of it as you lending money to the government when you purchase a bond (the most common types of government bonds being Treasury Bills and Canada Savings Bonds). You will earn regular income on your investment through interest payments that the government must pay you on a regular (usually monthly) schedule. When the bond matures– it expires and you will be given back the initial amount of money you invested in it.
Bonds are considered much safer investments than stocks, as you are guaranteed a regular stream of income through interest payments on fixed dates; plus the initial principal you invested. This is why bonds are also known as “fixed-income securities” and are generally very popular with conservative and risk-averse investors.
Mutual funds can be considered a hybrid investment vehicle – consisting of a combination of both stocks and bonds. With the philosophy that diversification (spreading out your capital over several investments) lowers risk and will generate a healthy long-term return on your investment, a single mutual fund may consist of dozens or more different equities and debt instruments- and types of mutual funds can vary according to the risk appetite of the investor. Some mutual funds may consist of debt/equities concentrated solely within a particular country, or a particular sector of the economy. Ownership of an individual share of a mutual fund is referred to as a “unit” of ownership (instead of a “share” in a company for stock ownership).
For more on the basics of stocks and bonds, check out https://www.investopedia.com/ask/answers/09/difference-between-bond-stock-market.asp.