Entire books have been written on how to understand the way pros talk about the stock market. If starting from scratch, though, it’s a good idea to begin by just discussing a few different investment options, also referred to as investment vehicles. An investment vehicle is anything you store your money in while expecting a return. They come with different levels of risk and different potentials for return. Let’s look at three of them – stocks, bonds and exchange-traded funds (ETF).
A stock (or security) is a tiny piece of a company. It’s traded on an exchange – commonly called a “stock exchange.” Stocks are bought and sold just like any other commodity and their price is determined by what people are willing to pay for them. Stocks tend to have the greatest volatility in price, meaning individual stocks vary more in price from day to day. They have higher possible returns, but also much greater risk than other investment vehicles. Stocks provide a return in two ways. They may pay dividends or periodic payments to all their stockholders. They may also increase in value, allowing investors to sell them for more than they originally paid.
A bond is a loan to a company or government. If a city wants to build a stadium, for example, it may choose to sell bonds. Investors buy them, giving the city money to complete the improvement. In exchange, the city makes regular “coupon” payments at a fixed percentage. At the end of the bond term, usually 10 years, the city pays back the initial investment. Bonds tend to be much less volatile than stocks. You’ll be more likely to get your money back, but you won’t get a share of the profits if the institution does really well. Bonds offer much lower risk, but also lower potential returns.
An ETF is a bundle of stocks managed by a professional investor. This person works full-time to implement an investment strategy, usually focusing on a specific sector or desired price. Some of these funds charge a fee for using your money, called a “load,” though no-load funds do exist. ETFs offer a middle ground between stocks and bonds. They offer some of the potential upside of a stock since their price is determined by the price of the stocks they own. Because they’re made up of many different stocks, they tend to be more resistant to big drops in stock price.
Don’t think of these vehicles as an either/or option. The best investment strategy involves a mixture of different investment vehicles based upon your individual tolerance for risk and your need for returns. Finding the right mixture of stocks, bonds and funds to secure your financial future will require some research and investigation, but you can do it. There’s no harm asking for help!