Stocks, Bonds, and More: The Building Blocks of Investing
Investing can help you achieve your most important financial goals, but understanding the options available is crucial. The key building blocks of investing include stocks, bonds, cash equivalents, mutual funds, and exchange-traded funds (ETFs). Below, we break down each investment type to help you determine the right fit for your financial journey.
Stock
A share, or part ownership, of a company.
How You Earn Returns: Stock prices fluctuate based on investor demand. Some stocks also pay dividends—money distributed periodically to investors. Dividends can be pocketed or reinvested to buy additional shares.
Risk: Stock prices can rise, fall, or even drop to zero. Younger or smaller companies, as well as those in volatile industries, may be riskier than larger, well-established firms.
Might Be Right for You If: You enjoy researching company fundamentals and are comfortable taking on higher risk for potentially higher returns.
Fees/Costs: You may pay trading fees or commissions every time you buy or sell shares.
Buy It: Through an account at a brokerage firm or directly from the company.
Bond
A loan to a corporation, federal or state government, or municipality.
How You Earn Returns: Interest is paid on the bond’s principal at a predetermined rate and schedule. At the end of the bond term, your principal is returned.
Risk: While issuers promise to repay your principal, there’s a risk of default. Bond prices fluctuate less than stock prices, but rising interest rates can reduce demand for existing bonds, lowering their prices.
Might Be Right for You If: You seek a stable income stream and want a less volatile option during market downturns.
Fees/Costs: Transaction fees often apply, usually as a markup on the bond price.
Buy It: Through an account at a brokerage firm or directly from the issuer.
Cash Equivalent
Short-term investments like U.S. Treasury bills or money market funds that can be easily converted to cash.
How You Earn Returns: Most cash equivalents pay interest.
Risk: While prices tend to be stable, returns may not keep up with inflation. They offer lower growth potential compared to higher-risk investments.
Might Be Right for You If: You have short-term spending needs or prefer low-risk options to avoid potential market losses.
Fees/Costs: Fees vary by investment type and may include transaction and early withdrawal fees.
Buy It: Through an account at a brokerage firm.
Mutual Fund
A professionally managed portfolio of diversified investments such as stocks, bonds, or both.
How You Earn Returns: Dividends, interest payments, and profits from underlying investments may be distributed to shareholders. Gains or losses also occur when you sell your shares.
Risk: Prices can fluctuate. Diversification reduces some risk but does not guarantee profit or protect against losses.
Might Be Right for You If: You want a convenient, professionally managed solution to diversify your portfolio.
Fees/Costs: Mutual funds have expense ratios covering management and operating costs. You may also pay transaction fees or sales loads when buying or selling shares.
Buy It: Through your retirement plan, a brokerage account, or directly from the mutual fund company.
Exchange-Traded Fund (ETF)
A collection of stocks, bonds, or other assets designed to mirror a market index or sector, traded on stock exchanges.
How You Earn Returns: ETF prices fluctuate based on demand and performance of the underlying investments. Dividends or interest from those investments are distributed to ETF holders.
Risk: Prices can go up and down. While diversification reduces some risk, it cannot eliminate it.
Might Be Right for You If: You prefer a low-cost, diversified investment option. ETFs are often more tax-efficient than mutual funds.
Fees/Costs: ETFs typically have lower expense ratios than mutual funds. Trading fees may apply, though many ETFs are commission-free.
Buy It: Through a brokerage account or retirement plan.
The Right Mix for Your Portfolio
Understanding these investment options is the first step toward building a portfolio that aligns with your financial goals. A diversified mix of investments can help you balance risk and potential returns, giving you the flexibility to navigate different market conditions.