Stocks, bonds and mutual funds – what are they?
Stocks and bonds are two of the most common types of “individual securities” investments. Mutual funds and ETF’s (Exchange Traded Funds) are vehicles for purchasing groups of stocks or bonds (or other securities). Investors buy shares, or partial/shared ownership, of such vehicles.
Stocks: Also referred to as “Equities” (i.e. ownership), stock owners own shares in publicly traded companies. Companies may be large or small, foreign or domestic, and share price values can fluctuate significantly depending on the company’s business decisions and economic cycles. Stocks are generally considered to have a higher volatility/price fluctuation risk, higher return profile.
Bonds: Also referred to as “Fixed Income,” bond owners own shares in the debt instruments issued by governments and/or private entities, such as companies. While bond prices and risk are also subject to economic and other factors, bond issuers (e.g. the US government) generally or always pay back the principal and interest of these loans, and therefore are generally a lower-risk investment, and as a result, bond issuers are not willing to pay high rates of interest (unless it is a high risk or “junk”/”high-yield” bond), and as a result are generally considered to have a lower volatility risk and return profile.
Mutual Funds and ETF’s: Mutual funds and ETF’s are investment companies or vehicles that purchase multiple stocks and/or bonds or other securities inside an account, and sell shares of that account to investors. This allows smaller investors to access greater diversification at lower cost than they would be able to access on their own. Volatility risk and return can vary greatly between mutual funds (or ETF’s) because the risk profile is dependent upon the mix of stocks and/or bonds selected by the investment company that manages a given fund. However, generally speaking, a stock mutual fund will have lower risk than most individual stocks, because of the diversification effect.
In summary, stocks vs. bonds can be simplified as owning vs. loaning, and mutual funds (or ETF’s) are buckets or packages of different combinations of stocks and bonds.