On this page I provide some explanation on investment terms, such as stocks, bonds, and mutual funds. Think of this as an entry level Investing class. Hopefully, by the end, you’ll feel more comfortable at your neighborhood barbeque when your friends start talking about their portfolios. You may even have some insight for them! I list some definitions at the bottom of the page that should help you along the way.
What is investing?
Simply put, investing money means you put your dollars towards something in the hopes that you will later gain some reward or profit. You can be directly involved in the project or not, but either way, you put dollars towards it. Contrast that with “saving” where you put money aside into a pile with minimal return to avoid losing it. With investing, you expect a good “return on investment” or ROI. That just means you hope to get more out of it than you put into it. With savings accounts, your ROI is so low that it’s almost zero, but you’re ok with that because your goal was to not lose it. With investing, you could lose it, but you could also get a better reward.
What can you invest in?
There are lots of options, but I’ll cover the most popular here. This includes stocks, bonds, mutual funds, and exchange traded funds or ETFs.
Stocks are essentially pieces of paper signifying ownership in a company. It is one type of security, or investment option. Owning at least one share of stock in a company makes you a stockholder. A company issues stocks that can then be purchased by anyone. Chances are that any major company you can think of today is a company that issues stock that can be purchased. You usually purchase these on a major stock exchange, such as the S&P 500 or Dow Jones Industrial Average(DJIA), or through your company(if your company offers them). When you hear someone talking about the “stock market,” they are referring to one of these exchanges where stocks are bought and sold. I just mentioned two that we have in the US and it’s important to know that countries all over the world have their own stock exchanges, so there are a lot more than just 2.
There are two main types of stocks: common and preferred. Common stock gives people the right to vote for things involving the leadership in the company that issues the stock. The more you own, the more votes you get. People who own common stock can also receive dividends if they are declared, but only after the preferred stockholders get theirs first. Preferred stock doesn’t give voting rights, but they do have priority over common stockholders in receiving payouts. Theoretically, there could only be enough money to pay towards all preferred stockholders and then there be nothing leftover for common stockholders. Historically, people have liked investing in stocks because they tend to perform well over time and even outperform other types of investments. For example, if you look at the average annualized return of the S&P 500 from 1928 until 2022, that number is 9.82% Stocks tend to have more risk associated with them than bonds. The price to buy a stock has a huge range starting from a penny up to several thousands of dollars for 1 share. Most are between the $10-$500 range.
Bonds
Bonds are debt instruments. You are buying the debt of another entity when you buy a bond. There is no ownership involved like in a stock. Bonds are also a fixed-income instrument, meaning they pay you a certain amount of predetermined money with each payment, which could be monthly or another timeframe. Bonds also have a maturity date, meaning your money is paid back to you in full once that day is reached. So, you invest money up front, get paid a little along the way, and then get your money back at the end. Companies or governments can issue bonds. This is typically in response to a need to raise money for something. If you live in a city where a major construction project just took place, it was probably funded by selling bonds. So, while construction is under way, the bondholders are getting regular interest payments and then expect to be paid back their investment at the end, which could be several years. There are many terms involving bonds and many types of bonds, so I’m going to keep it simple here. Know that a bond represents debt, and anyone can buy them. They typically cost about $1,000 per bond, but the price can vary and even change during the life of the bond if the investor decides to sell it before maturity.
Mutual fund(MF)
Not everybody has thousands of dollars to get started investing, so what options are available to them? That’s where mutual funds come in. Mutual funds are pooled investments from multiple people. All the pooled money is managed by a fund manager. Mutual funds have many investments inside of them, and are usually categorized based on different sectors. For example, you could have a Technology MF, a Finance MF, a bond MF, and many others. You can buy into it with less than $100. If you have a 401k at work, your investment options are probably all mutual funds. These are very popular for investors because they seek to maximize profit while minimizing risk. You probably remember several companies in your lifetime that went from being very profitable to bankrupt in a very short period of time. If you were an investor in those companies, you lost money. In Mutual Funds, if one of the companies inside the fund goes bankrupt, there are always many others that are still kicking so the fund won’t suffer as much as a stock would. You can buy fractions of a share in a mutual fund, which is why you can get started with less money. For anyone who isn’t investing in anything right now and isn’t sure where to get started, mutual funds can be a great place to start. You can pick an area that interests you and likely invest in a mutual fund that aligns with your interest.
Exchange traded funds(ETFs)
These funds are like mutual funds. They are different in that instead of pooling together a bunch of investments to achieve a stated goal, ETFs invest in multiple instruments designed to mirror a stock exchange. For example, if the S&P 500 gained 10% one year, then you would expect a S&P 500 ETF to also gain 10% that year. The ETF would rise and fall at the same level as the stock exchange it mirrors. There are many ETFs, and they all mirror an exchange. These are popular investment funds because of the simplicity in which they operate. Earlier I stated that the annualized return for the S&P 500 was 9.82%. Since it’s nearly impossible to invest in every single company inside of the S&P 500, you could simply buy shares of the S&P 500 ETF and accomplish the same thing for much less money up front.
Definitions:
Dividend: a company pays out money to people who own stock. The purpose of dividends is to share profits with stockholders. When a dividend is announced by the company(quarterly or annually), that means anyone who owns stock will get some extra money that is paid separately from the stock they already own.
Stockholder: a person who owns stock
Shares: stock certificates are expressed as “shares.” So, 100 shares of stock means you have 100 stock certificates, or pieces of paper that show you own a single stock.
Return on investment(ROI): What are you getting back for what you put into it? For example, if you invest $100 and get $200 back, is that a good return? If you invest $100 and get $50 back, is that good? In either scenario, you have a return on investment, whether it is good or bad.
Stock exchange: a place where stocks and other investment instruments are bought and sold. Examples include the S&P 500 and the Dow Jones Industrial Average(DJIA). There are numerous examples of these in existence.
Annualized rate of return: if you add up your total gain in an investment over a period of time and divide it by the number of years, you get your annualized rate of return. For example, if your investment went from $100 to $200 over a 10 year period, that’s a total return of 100%. If you divide 100% by 10 years, you get 10% per year. 10% is your annualized rate of return.
Instrument: a type of investment, like a stock or bond.
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