Stocks, Bonds, and Mutual funds are all investment assets I’ve mentioned in previous articles, but I wanted to do a deeper dive here.
So a quick review first.
1) Stock — share of a company that denotes ownership.
2) Bond — debt security sold to a buyer that accrues interest.
3) Mutual fund — a bundle of stocks or bonds managed by a team of investors.
Now a deeper dive.
A) Stocks, as stated earlier, make you a partial owner of a company. Owning stock gives several benefits, a claim to profits, possible voting rights, and or dividend payments. If the company does well, your stock value may increase, but if it doesn’t, your stock value may decrease, or even worse, if the company goes under, you may lose your investment entirely. These are the riskiest of the three assets I will go over today.
1) Earnings per share is the net earnings of a company divided by the company’s shares.
2) Price-to-earnings ratio or P/E, is the stock price divided by the most recent four quarters of earnings which tells you how much you are paying for a dollar of earnings and denotes how fast the company is expected to grow.
3) Dividend Yield is a company’s annual dividend payment divided by its stock price.
Pro tip-when investing in stocks have some familiarity. Analysts and research will give you insight into a stock but remember it is your decision, so be confident and informed.
B) Bonds, do gentlemen still prefer bonds? There used to be an adage about how gentlemen preferred them because they were less risky assets. The fixed payment schedule and protection of principle were more suitable for many investors who saw stocks as gambling. But that was a different time, and now financial institutions have made various bonds just as volatile as the market. Even worse, bonds don’t always keep up with inflation which drives many people into stocks as a way to beat inflation. Bonds are a form of IOU that you purchase for a set time, and the seller pays you interest and then returns your initial investment.
Types of bonds
1) Treasury sold by the federal government.
2) Municipal sold by state and local governments.
3) Corporate sold by corporations.
4) Junk bonds sold by anyone are bonds with low credit ratings but pay out high rates, but that is because of the risk.
(there are taxes and tax exemptions but that is for another time)
1) Credit risk depending on the issuer of the bond their creditworthiness will be examined and rated. The higher the rating the more likely the payment, high ratings usually give out lower rates and lower ratings give higher rates but have more risk.
2) Intrest rate risk if the federal reserve issues new bonds at higher rates people will seek them out as opposed to existing ones lowering the value. New bond issues at $1000 paying 5% or $50 a year force an old bond which was 1000 a year paying 4% or $40 to be valued at $800 so it pays equal to the 5% of the newly issued bond.
Pro tip- this took me a while to understand, so I will try my best to explain it here. Price and yield on bonds are inversely correlated. When you purchase a bond, it has a set payment the issuer has agreed to pay you payment/princple=yield. Simple enough, but what happens when you sell it? The payout stays the same, but the price may change. If you sell the bond for more than you paid, the yield goes down, but if you sell it for less, the yield goes up. For example, I have a bond that pays $10, and I paid $100 for it, so a 10% yield I sell it to you for $200, you still get $10, but instead of it being 10%, it is now 5%. Why would you do that? You still get my principle of $100 plus the $10 annually, which over time may cover the cost you bought it for and then some. Conversely, if I sell the same bond I paid $100 for, and it pays $10 annually to you for 50, you are getting a 20% yield and my original principle.
C) Mutual Funds unlike the previous two categories, I won’t spend as much time here because this is the most basic of the assets. I’m going to breeze through a few types and give you the just of it. The most important things to look at are the expense ratios, what makes up the fund, and its performance history. That is really it. Like stocks, you can analyze them and should do so.
1) Index Funds are a passively managed bundle of stocks or bonds that match a stock or bond index.
2) Balanced Funds that try to mix stocks and bonds. The funds are managed by someone trying to manage income flow from bonds and asset growth with stocks.
3) Life Cycle Funds are funds that are managed with a retirement date or style in mind. They mix stocks and bonds to achieve this.
4) Sector Funds target particular sectors of the stock or bond market. They carry a little more risk as they aren’t diversified but give you broad exposure to a sector.
5) ETF or Exchange Traded Funds are mutual funds that trade throughout the day.
6) Money Market Funds are open-ended mutual funds that function similarly to a savings account. Your money is still kinda liquid.
So this went a little longer than I expected, but I had a lot to fill in. If you want more information, keep following me here. You can also comment below or read my previous articles. Again I’m not a financial advisor, and you should seek out your own, but this is general guidance and information I am sharing with you.
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