Retail investors, at times, are clueless about the difference between stocks, bonds, and mutual funds. In fact, some of them mistake these as synonymous. These popular investment instruments are very different from each other. Retail investors may be unaware of their differences or find them confusing. Let us simplify them for you.
Stocks: A stock means the ownership of a company. When someone buys a stock, he/she buys a piece of the company. And the value of their shares goes up and down as the company’s perceived market value fluctuates. Corporations sell shares of stock (ownership in the company) as a standard method to raise capital for expansion, modernization etc. without resorting to borrowing from banks etc. They are certificates of equity and are considered riskier as compared to other types of investments. Investment in a good company, i.e. stocks can give staggering returns in the long term.
Bonds: If one has to describe a bond most succinctly and appropriately, then it would be apt to say that bond is a loan. When someone invests in a bond, or purchases a bond, he/she loans their money to the government or a company (depending weather the bond is government bond or a bond issued by a company). Like all loans, bonds come with an interest component which can involve periodic payments over the life of the bond or a single payment at maturity.
Bonds fall in the category of conservative investments as one can choose the length and term of the bond and know exactly how much money he/she will get back at the end of the term or “maturity.” There are numerous forms of bonds, e.g., government bonds, corporate bonds, short-term bonds, long-term bonds, municipal and inflation-protected bonds, etc.
They are less risky than stocks. You would lose your money on a bond only if the company or the government defaults on their obligations. It is highly unlikely to happen especially with government bonds.
Mutual Funds: Mutual funds are the collections of stocks, bonds, and other investment securities. They are managed by financial experts or professional fund managers to maximize returns. Mutual funds often contain stocks and bonds from many different companies. These funds are merely a way for a group of investors to pool their money so they can invest, as outlined above, in a wider variety of stocks and bonds.
The value of one’s shares, in a mutual fund, goes up and down as the value of the stocks and bonds in the fund rise and fall. To contrast, while in stocks one is mainly investing in one company, whereas in mutual funds, one’s money is invested in dozens of companies all at once. This built-in diversification can provide a certain amount of security that stocks do not provide while leaving your funds secure yet still give you access to similar financial gains. Mutual Funds are further classified as Equity funds, Hybrid funds, and Debt funds. You may click on the following link to get insight into different types of mutual funds.