Stocks, bonds, and mutual funds are three terms we come across while watching TV, reading the newspaper, or discussing retirement. However, unless you are a business major or possess the intellectual curiosity necessary to decipher these definitions on your own, then you probably do not fully understand their functions.
Companies sell stock in order to raise money. The buyer of stock then has an ownership in the company and can help make decisions about the leadership of the company through a voting process. You can make money by owning stock in two ways. The first occurs when someone is willing to pay more for your stock than the price you paid for it, which is known as price appreciation. The second is when a company chooses to distribute periodic payments to shareholders, this is known as a dividend payment.
Bonds are similar to stock because companies sell them to raise capital. However, when buying a bond you are not buying ownership in the company but instead you are essentially giving the company a loan. When a bond is issued, the issuer promises to pay you a certain amount (usually $1000) when the bond matures. You make money because you buy the bond for less than $1000. For example, if you purchase the bond for $900 and it matures in one year then you make $100 or an 11.1% return. Another way to profit from owning bonds is that they can provide a fixed interest payment to the owner. For example, if the bond has a 5% annual interest rate, you will receive $50 annually from owning the bond plus your gain when the bond matures.
A mutual fund pools the money of many individuals to invest in stocks and bonds. When you invest money in a mutual fund, you receive shares of the fund. Each share represents an interest in the fund’s portfolio and the value of your mutual fund shares will rise or fall depending on the performance of the stocks and bonds within the mutual fund. A mutual fund is managed by professional investment advisors who have the ability to buy and sell the stocks and bonds within the portfolio.
Matt Kiehl Peer Counselor II Powercat Financial Counseling www.k-state.edu/pfc