Understanding Stocks and Bonds: A Beginners Guide to Investing

We talk a lot about stocks and bonds in the investment world but what actually are they? What is the difference between them? We look forward to exploring these fundamental investment options in today’s coffee and cash discussion.

Let’s talk about stocks first. A stock represents ownership of a company. If you purchase a share of stock in a publicly traded company, you are purchasing a tiny ownership portion of that actual company. This ownership comes with a number of different benefits. As a partial owner of the company, you have the potential opportunity to make money as the company makes money. This can happen in one of two ways:

(1)    The company can distribute a portion of company profits to their stockholders in the form of a “dividend”. For example, if a company has 100 outstanding shares of stock and they issue a $100 dividend, each stockholder will receive $1 for each share that they own.

(2)    The other way for the owner of a stock to earn money is through increasing value of the stock itself, called capital appreciation. Let’s say you purchased a share of Company A’s stock 5 years ago for $50, today that same stock is worth $172. That is a lot of growth! If you choose to sell your share of Company A stock when it was worth $172, you will have earned $122 from the increased value of the stock between the time you purchased and sold the stock shares.

In summary, a stock represents ownership of a company and you can make money owning a stock by receiving dividends or realizing increases in stock value by selling the stock for more than you bought it for.

Now let’s talk about bonds. Think about  bonds as loans, the owner of a bond is essentially lending money to a company (called a corporate bond) or a government entity (think federal treasury bonds or local municipal bonds). In this case the owner of a bond does not own any portion of the company or government entity itself, rather they have lent the entity money and the entity pays the owner interest on that loan over time. Most bonds are issued with a “par” value or repayment price of $1,000. At the end of the bonds term, the lender receives the “par” value, $1,000 plus the final interest payment on the bond. For example, lets say you buy a 10-year bond from Company A with a 5% “coupon” rate. You initially give Company A $1,000, and they agree to pay you $50 per year for 10 years, until you reach the bond’s maturity date. Since bonds often pay interest twice a year, you should expect to receive 2 $25 interest payments per year until the bond matures. After all 10 years have passed, you receive your original $1,000 loan back, along with your final interest payment of $25. In summary, bonds are loans made to the issuer, they pay interest for a period of time before paying back the full amount at maturity.

Since stocks and bonds ultimately make up most people’s investment portfolios (whether directly or indirectly), we hope these quick, clear summaries help you better understand the foundations of your investment accounts. Remember, as always if you have any questions about this or other financial topics impacting your life at the present, don’t hesitate to reach out to us.