There is a lot of confusing investing terminology that is out there. As an investor, you may not need to know it all, but you should have a solid understanding of the basics. Here are two basic terms that everyone should understand before they risk their hard-earned dollars:
- Stocks: When a company seeks to grow and expand their business, they sell shares known as stock, which is essentially ownership in the company. Investors can make money on these shares by buying them when they have a lower value and selling them when they have a higher value. Investors can also make money in stocks by receiving regular payouts from the company, also known as dividends. Dividends are not always part of every stock that is sold; however, it is dividends plus changes in share price that end up determining one’s total return on his or her investment.
- Bonds: When you buy a bond, you are actually loaning money to a company, the government, or a government agency. This is often done for capital improvement projects, which likely have some sort of predetermined budget for which funds need to be raised through the issuing of bonds. During the life of the bond, there is a fixed level of interest that is paid out to the lender. This interest is in essence money you are given by the borrower for letting them use your money for a time. At the end of the life of the bond, the money is returned to you, the lender.
In comparing the two, bonds are typically considered more conservative than stocks, but historically have lower returns. Stocks, on the other hand, tend to be more volatile, but over time typically have a much higher rate of return.
In summary, a stock is ownership in a company. A bond is an interest-bearing loan you are giving to another entity. Both earn a return but in different ways. Knowing the difference is important, as both can play their own distinct roles in your financial portfolio.