finance, Uncategorized

The Simple Difference Between Stocks and Bonds

How the HECK have I not addressed this topic yet!? Learning the difference between stocks and bonds is one if the first things I learned in finance. I honestly had no idea they were 2 separate things, but it’s pretty important AND easy to understand the basics.

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Stocks represent ownership of shares in a company. 

Basically the company wanted to raise some money, so they ‘went public’ and got approved to sell their stock. That stock is then valued based on many things…but the price you pay is largely based on how much everyone else values it! Just as a nugget of wisdom- people don’t always value the stock for what it’s actually worth. Surprise surprise, people can be totally wrong, but we can get more into stock valuation later.

Anyways- you can buy and sell stock on the secondary markets. It goes up in value when lots of people want it, and it goes down when people don’t want it. Owning stock doesn’t mean you own the company- rather you own a share in a company. That distinction may seem small but it’s important. It means you don’t have legal liability in the company, but you can get some benefits. You can sell your stock (hopefully for more than you bought it), you may have voting rights, and you might get to share in the company profits (dividends).

The main take away- when you are buying stock you are investing in the company or the idea that other people will later value that company at a higher price.

 


Bonds on the other hand represent DEBT and are a type of fixed income investment. If I buy a bond then I have given a loan to the corporation or government entity (depending on who issued the bond). I get the money I lent back PLUS interest. Lets look at an example:

California wants to build a new toll road. In order to raise the funds to buy the materials and pay the workers- they decide to sell bonds. Each bond can be purchased for $1000. I buy a bond for $1000 and California agrees to pay me back the full $1000 in 5 years…and in the meantime, they will send me a $50 check every year. In five years I would have received not only my $1000, but an additional $250 because the interest.

There are a ton of different types of bonds, and you can acquire them from the sellers themselves or on the secondary market.


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