If you’re just starting out as an investor and building the first portfolio you’ve probably been told diversification is key. Having investments in stocks, mutual funds, and bonds can help us to keep a well-diversified and strong portfolio. But what is the difference between stocks, mutual funds, and bonds? Why is it important to know what each one is and offers before making an investment?
Keep reading to learn the difference between stocks, bonds, and mutual funds; and knowing the difference can help you have a strong successful portfolio.
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A stock is a small amount of ownership in a company. You won’t be able to buy a controlling number of shares (typically) but you will be able to vote on certain gongs on within the company itself.
Stocks are sold by the share with each share being worth a certain amount. The price of the shares rises and falls throughout the day. If the price of the shares you bought rise after you bought them, you will have made money on your investment. If they fall below though then you’ve lost money on your investment.
What makes stocks risky is that they rely on the success of the company. If the company tanks or goes under your shares will likely be worthless and you will have lost your investment. Likewise, if the company succeeds and grows, then share prices will rise and so will your investment.
The more shares you have the more you stand to be rewarded when the company does well and the more money you stand to make. However, similarly the more shares you buy the greater risk of a great loss. Do your research into the stocks to buy today to make sure you choose the best stocks for your portfolio.
Think of bonds as a form of a loan. Except for the lender are you the investor. And the loan recipient is the government or a company.
It works like this; a hospital puts up bonds for sale in order to buy new equipment needed. They release the number of bonds needed to fund the project, and investors buy the bonds. The idea is that the company will pay back your investment with interest.
Bonds are safer than the stocks to buy today when it comes to the risk of loss. This is because the only way to really lose any money on bonds is if the government or company failed to meet their obligations.
It’s always a good idea to research a company before purchasing stocks and the same is true for bonds. Make sure the business doesn’t have a history or defaulting on bonds. Also, look at the terms of the bonds and make sure it is an investment you can truly support.
Having bonds in your portfolio along with stocks will help to offset any losses from the stocks should those companies suffer a drop-in share price. There are many factors that contribute to share price and even experts have a hard time predicting the changes in price. Having bonds to balance your portfolio can save you some heartache in the future.
Mutual funds are a collection of stocks and bonds that you can purchase shares of. Your investment is then disbursed across several stocks and bonds by the fund manager.
Mutual funds have a few categories to include aggressive with high risk, and non-aggressive with low risk. Before deciding, do your research into the fund and read their prospectus. Pay particular attention to the fund’s investment objective, risks, fees, and expenses.
Mutual funds offer more security than stocks due to your investment being spread across dozens if not hundreds of securities. This gives you the best chance of not losing your investment and increasing your chance of reward.
When you’re just starting out in investing you want to have as diverse a portfolio as possible. But you also want to know what the different types of securities are. This way you can effectively balance your portfolio.
For example, if you want to invest in a risky stock you might want to buy a few more bonds in case the stock drops. Your portfolio worth as a whole won’t take that big of a hit if you lose some of your initial investment on the risky stock.
InfoGraphic on Bond
The image below shows the basic information about Bond, Terms associated with Bonds such as Face Value, Coupon, Maturity, Bond Yield, Types of Bonds such as Zero Coupon Bonds, Treasury Bills.
Always do your research before making any investment so you stand the best chance of earning a reward on your investment rather than losing it all.