Learn About Investing in Stocks, Mutual Funds, and Bonds

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The 10 Basic Principles of Investing (3)

It's very likely that you'll try several investment strategies before you find the one that best suits your goals and investing style, but there are some basic investing principles that …

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The term ‘stocks’ is used often in the investment world. While many of us use the term we may not fully understand it’s meaning. When you are a stock owner it literally means you are a part owner of a company.

Many companies, once they become large enough, start issuing stocks. This simply means that you can purchase a small part of that company by purchasing one or more shares of the stock. The number of shares you purchase will depend on how many you want to own, and how many are available for purchase. The advantage of owning shares is that as the company’s success increases so does the value of the shares you purchased. However, if the company does not grow then the value of the stock may not increase, or it may even go down in value. Just as there are people who make a lot of money in the stock market there are also many people who have lost a lot of money in the stock market.

There are two main types of stocks:

  1. Common stocks: this type of stock usually allows the stock owner to vote at shareholders’ meetings, and to receive dividends (see below). Although this stock may offer higher rate of returns this comes with additional risk. If the company were to go bankrupt you will be the last on the list to receive any money owed.
  2. Preferred stocks: this type does not allow the owner to be involved in voting, but offers a higher claim on earning and assets. This means if the company was to claim bankruptcy, preferred stock owners would be compensated before common stock owners. This type also pays a fixed rate of dividends which is usually guaranteed.

Stocks can be purchased through several avenues. You may do this through a broker (for a fee of course). This broker can be a full-service broker, meaning they offer you advice and take care of the administrative work. Or, it can be a discount broker, which will not offer advice and you are more involved in the administration. Discount brokers are usually used via the internet. There are companies, including banks, that offer this service. The way it works is you open up an account, deposit some money into the account, and then execute a purchase of stocks with the money in the account, over the internet.

A mutual fund is an investment in several smaller investments. For example, a single fund may include stocks or bonds from several companies. It can also include money markets, and securities. Mutual funds are always operated by what’s called a fund manager. This manager is responsible for investing the funds in ways that will earn maximum return, and is paid, in part, on his/her success. There are many types of mutual funds to meet almost everyone’s risk level.

A bond is a security that is issued by a company. When investors purchase the bond the company receives money that it can invest and grow. However, at a given point in time, the company promises to return, to the bond owner, the original value of the bond plus interest. Another way of looking at a bond is that it is a form of loan, where the individual lends money to the company, with a promise of a return. Governments issue bonds to anyone wishing to lend it money. It is a simple and secure way to invest your money. However, because some bonds are virtually risk-free there is also very little return. Many times the return is not even as high as the inflation rate.