Investing can be a great way to grow your money, but if you don’t know much about it, you might not know where to start. Terms like stocks, bonds, mutual funds and exchange traded funds (ETFs) may seem intimidating. With all the options available, many people aren’t sure where to begin, but knowing what these terms mean might help provide a better starting point.
Stocks are ownership shares of a company. When you buy stocks from Proctor & Gamble or Amazon, you will partially own the company. You can even vote at a shareholder’s meeting. You receive profits that the company allocates to its owners, known as dividends.
However, the stock market can be volatile, and the value of a stock can change every day. One day, your shares could be worth $80 a share, and the next day, a PR blunder or other market trend could cause shares to plummet to half that. Or the opposite could happen: you purchase stock shares, and they go up quickly. The takeaway: you could make a lot of money, or you could lose money.
Bonds are a “fixed-income” investment, which means that they pay returns on a regular basis, and if you purchase them from a stable government, they’re a relatively stable investment. When you buy a bond, you’re lending money to that government. Similarly, you can buy a bond issued by a company, which can be more risky than a stable government bond, depending on the quality of the company. Like government bonds, when you buy a corporate bond, you are lending money to the company and they commit to repay it. In return, you get interest income and, eventually, the value of the bond.
Because most bonds are relatively low risk, they’re an attractive investment. However, with low risk comes low return, which is important when considering your financial goals.
If you like the idea of a mix of high-risk and low-risk investments, mutual funds might be right for you.. The word “mutual” comes from the fact that you’re pooling your money with other investors. Different mutual funds are set up with different strategies: some might be all stocks, some might be all bonds, or they could be a mix. Essentially, mutual funds are a collection of stocks and bonds managed by a professional fund manager.
Many people use mutual funds as a way to get a mix of large stocks, small stocks, domestic bonds, foreign bonds, etc., which is designed to give you a more balanced portfolio than by buying them individually – when one goes up in value, another may go down. The goal on the whole might be to achieve a higher return, with lower risk than any one of them individually. As with any investment, however, there is risk involved and no particular return guaranteed.
Exchange Traded Funds (ETFs)
Exchange traded funds (ETFs) track indexes like the S&P 500 or Russell 1000, a basket of assets, or commodities. It sounds like a mutual fund, but unlike a mutual fund, ETFs are traded like stock on a stock exchange. And unlike stocks, you don’t directly own a company or assets; you indirectly own them and are paid a portion of the profits (or dividends).
One reason why you might consider ETFs is the diversification—you get a mix of assets. There’s also less taxation, and the barrier to entry (or cost) is low. However, there is still risk involved, so it’s important to understand their underlying investments.
When you’re just starting out, it’s helpful to know the basics of stocks, bonds, mutual funds, and ETFs, including any fees involved. When you’re ready, consider starting to invest as a way to start growing your hard-earned money, and as part of your retirement strategy.