A stock is ownership in a company. You buy a piece of the company, when you buy a stock. So if the company tanks, your stock tanks. Congruently, if the company does well, you do well. There are many types of stocks just like bonds, because there are many different types of companies out there. Large company stocks (large cap), small cap stock, mid cap stock, emerging stock, international stock, tech stock, etc.
Historically, stocks have an annual average return of 10.8%. However, remember that with more revenue comes more risk. So if you plan to invest in stocks, keep in mind that you have to be able to handle the extra risk or volatility that comes with it, in-order to reap the potential reward in the long run.
Using the Rule of 72, if you have $5,000 in stocks that average 10% return overtime, it will take you 7.0 years to double your original investment to $10,000. You will have potentially $160,000, by the end of 36 years. Compare that to the $10,000 you will have after 36 years if you leave your money in just cash investments. From here you can have an idea why taking on the extra risk can become worth it in the long run.
A loan is the best way to describe a bond. You loan your money to a company or the government, and in return they pay you interest for the term of that loan. Bonds are typically considered conservative types of investments because you can choose the term and length of the bond and know exactly how much money you will get back at the end of the term or “maturity.” There are many types of bonds; corporate bonds, government bonds, long-term bonds, short-term bonds, municipal and inflation protected bonds, etc.
The main way you lose money on a bond is if the government or company issuing the bond defaults on their obligations, thus making them less risky than stocks. Historically, bonds have an annual average total return of 6.3%. Using the Rule of 72, if you have $4,000 in bonds that average 6% return overtime, it will take you 12 years to double your original investment to $8,000. Better than cash but still not that great.
Bonds are subject to interest rate risk and market risk if sold prior to maturity. As interest rates rises bond values will decline and bonds are subject to availability and change in price.
Mutual funds represent another way to invest in bond, stocks, or cash alternatives. You can think of a mutual fund like a basket of bonds or stocks. Basically, your money along with the money of other investors is pooled into a fund, which then according to a stated investment strategy is invested in certain securities. The fund is managed by a fund manager who reports to a board of directors.
By investing in the fund, you own a piece of the pie (total portfolio), which could include anywhere from a few dozen to hundreds of securities. This provides you with instant diversification that would be more difficult & expensive to achieve on your own along with providing a convenient way to obtain professional money management.
Every mutual fund publishes a prospectus. Before investing in a mutual fund, get a copy and carefully review the information it contains, such as the fund’s investment objective, fees, expenses and risks. Carefully consider those factors as well as others before investing.