Have you ever heard people say things like, “The market was up today,” or “I just looked at the news, and my stocks are all down”? Or maybe you’ve seen headlines like “Investors Moving into Bonds as Rates Fall,” or “Index ETFs Gain in Popularity.” Maybe you’ve wondered about this unfamiliar language that other people seem to understand. Maybe you wish you understood more about it yourself.
The world of finance and investing can certainly be a complicated place, but the good news for young or inexperienced investors is that it is built on a few principles that aren’t all that difficult. Let’s take a look at a few common terms that can help you start to get more comfortable with the financial markets and the ways that everyday investors interact with them.
Stock. At its most simplistic level, a stock represents a portion of ownership of a company. Businesses that want to expand their operations issue “shares” of stock in the company to the public (i.e., they are “publicly traded” companies), and they use the money to improve the business: building new infrastructure, creating new products, or some other initiative. Stocks of such companies, which can be huge corporations like Apple Computer or small, “start-up” companies that few know about, are traded on “exchanges”: a physical or online location where buyers and sellers come together. The New York Stock Exchange, located on Wall Street in Manhattan, is one of the world’s largest such exchanges. So, if you own a single share of stock, you are one of the company’s owners, entitled to share in any profits generated by the company. When the company is doing well, your stock is more likely to increase in value. On the other hand, if the company is not doing well, your share is more likely to decrease in value.
Bond. A bond, rather than representing ownership, is a debt instrument. In other words, when you buy a bond, you are loaning money to the entity that issued the bond, and you will be paid interest on the amount of the loan until the bond comes due, or “matures,” at which time you will receive back the amount of money you loaned (the “face amount” of the bond). Bonds can be issued by private companies or by local, state, or national governments. US Treasury bonds, generally considered the safest debt instruments, are backed by the full faith and credit of the US government. So, if you purchase a 10-year US Treasury bond with a face value of $1,000 and an interest (or “coupon”) rate of 3%, the government guarantees that you will receive $30 per year in interest for 10 years, and at the end of the period, you will get your $1,000 back. Like stocks, bonds are traded on exchanges, and their value can go up or down, depending on the opinions of buyers and sellers as to the underlying value of the bond. Generally, when interest rates are rising, previously issued bonds become less valuable, because they were issued at lower interest rates. On the other hand, when interest rates are falling, those same bonds may become more valuable, since they carry a higher coupon rate than newer bonds. If the entity issuing the bonds gets into financial trouble, some bond owners are more likely to get some of their investment back as compared to stockholders, whom typically have no such protection. This, along with the various guarantees that the issuers may provide when selling the bonds, is why bonds are generally considered to be “safer” than stocks. But, like stocks, the value of bonds before maturity can go up or down, depending on the perceptions of buyers and sellers.
Mutual fund. In basic terms, a mutual fund is a pool of money from a group of investors that can be used to buy stocks, bonds, or other valuable assets. The investors purchase shares of the fund, and the manager of the fund invests the money in whatever type of assets the fund is organized to buy. Mutual funds provide investors with a “prospectus,” which is a document that describes the fund: what it buys, how it is managed, any fees charged by the fund manager, and other important, legally required information. Mutual fund investors receive profits or other income from the fund according to the number of shares they own. As with stocks and bonds, the value of mutual fund shares can go up or down, depending on the value of the assets in the fund. Mutual funds offer the convenience of allowing purchases of fractional shares; an investor can buy a certain dollar amount of a mutual fund. Transactions by a mutual fund occur once per day, so that all shareholders will receive the same buying or selling price.
Exchange-traded funds (ETFs). ETFs are similar to mutual funds, in that they are composed of a pool of assets provided by investors purchasing shares in the fund. Unlike mutual funds, however, ETFs are traded continuously like stocks and bonds; an investor who buys shares in an ETF at one time of the day may pay a different price than one who buys at a different time. Purchases and sales of ETFs are executed in whole-share amounts only.
For more information. Of course, there’s a lot more to investing and the financial markets, and for those who want to learn more, plenty of free online resources are available. Here are a few trusted sources where you can expand your knowledge:
- U.S. News & World Report, “12 Terms Every Investor Needs to Know,” https://money.usnews.com/investing-101/articles/terms-every-investor-needs-to-know
- Investopedia.com, “How to Invest in Stocks: A Beginner’s Guide,” https://www.investopedia.com/articles/basics/06/invest1000.asp
- Investopedia.com, “4 Basic Things to Know about Bonds,” https://www.investopedia.com/articles/bonds/08/bond-market-basics.asp
- Investor.gov, “Mutual Funds,” https://www.investor.gov/introduction-investing/investing-basics/investment-products/mutual-funds-and-exchange-traded-1
- Nerdwallet, “What Is an ETF?” https://www.nerdwallet.com/article/investing/what-is-an-etf
At Griffin Black, our goal is to provide you with the authoritative information you need to reach your financial goals. To learn more, click here to read our article, “When Concentration Isn’t Good for You.”