Explain Stocks, Bonds, and Mutual Funds
Do you ever feel financially illiterate? Do you turn on CNBC only find yourself completely dumbfounded by what they are saying? Do you wish you at least new something about investing so that you could chat with your friends about the ‘markets’? Don’t worry, the basics aren’t as hard as you think.
If you want to invest in the stock market, you have to know a little about what you are doing. When a company goes public, they begin to sell shares of stock on a public stock exchange such as the New York Stock Exchange (NYSE). One share of stock has a price which continually fluctuates on a daily basis. Your goal is to buy a share of stock at one price, and then sell the share at a higher price on a later date.
When you own a share of stock, even just one, you own part of the company. If you own stock, you are referred to as a shareholder. You can vote in the company, but your vote is usually only good for choosing those on the board of directors who makes the big decisions, unless you own a large part of the company.
A stock is considered an equity security because you own part of the company. A bond is considered a debt security because you lend the company money, you don’t own any of it. You can buy bonds from the government, state, bank, or a corporation. If you buy a bond for $1,000 that matures in 10 years with an effective interest rate of 5% paid annually, every year you will receive $50 until the 10 years are up at which time they will pay you back the $1,000.
You can hold bonds to maturity or you can buy and sell them. Bonds bought from the government usually have little to no risk. Corporate and municipal bonds have a rating that will tell you how risky they are.
Bonds are rated by letters. For example, a AAA is the highest rating which means it has the lowest risk by those usually have the lowest return as well. They are rated also as BBB, CCC, etc. The lower they go, the riskier they are.
Mutual funds are a mix of stocks and/or bonds. They work by pooling together a bunch of peoples money and a fund manager invests the money in several different investments for you.
Mutual funds are great for new investors or for those who aren’t interested in buying their own stocks but want a diversified portfolio. No-load funds are a popular choice because they charge no fees.
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