Since diversification is always recommended in investing, the beginning investor will want to learn the basic differences between the products available. For example, three popular investments are stocks, bonds and mutual funds. Knowing how these investments differ can help the beginning investor on the way to determining what products fit a personal diversified portfolio.
The major issuers of bonds are the U.S. government and affiliated agencies, state and local governments and corporations. Governments do not issue stock shares, which represent ownership in a business. Public corporations are by far the biggest issuer of stocks. Investment companies pool resources from investors and purchase assets with the capital to form mutual funds. These underlying assets may be stocks, bonds, commodities, money market securities or other investment products.
Bondholders are creditors to the entity that issues the bonds to investors. Stockholders are part owners in the business. Investors in mutual funds own shares of a fund that may hold stocks, bonds or other investments as the underlying assets. Mutual fund investors do not own the actual assets. The mutual fund, the investment company itself, owns the assets and investors own shares in the fund, which amounts to a claim on the assets based on the overall percentage of the fund owned.
Stocks and mutual funds trade in shares. Both stocks and mutual funds may also produce dividends paid to the shareholders. Bonds, on the other hand, earn interest and are not traded in the open markets in shares but instead are sold and traded in specific dollar amounts. However, mutual funds that hold bonds as the underlying assets can be bought and sold in individual shares.
Bonds are generally much more affected by current interest rates than stocks. With mutual funds, it depends on the assets the fund owns. Bond prices fall when interest rates rise and vice versa. With stocks, interest rates have no direct immediate effect on prices or value, unless investor sentiment causes an immediate reaction and consequently results in price volatility.
Stock prices may fluctuate throughout the trading day. Shares in mutual funds are generally calculated once daily at the end of trading. The value of the underlying assets determines the NAV, or net asset value of the mutual fund shares. Called fixed-income securities, the income stream from bonds is known if the bond is held to maturity.
Rank of Claims
One main difference between stocks and bonds is the rank of priority investors have on claiming the assets of a corporation should the business suffer bankruptcy. Of course, secured creditors, such as lenders who hold a mortgage on property, get first claim on assets. Secured bondholders also fall into this category if some type of collateral backs the bond. Bondholders of unsecured bonds, also creditors to the business are paid before stockholders.
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