The Difference Between Stocks, Bonds & Mutual Funds

Knowing investment basics can help you build your nest egg
i Jupiterimages/BananaStock/Getty Images

Gaining knowledge of different types of investments should not be something you put off. Saving a part of your salary and investing it is a major way of assuring your financial future and retirement years will be secure. Even if your employer manages your retirement account through a financial planner, you should make the effort to understand how your money is invested and to know the difference between stocks, bonds and mutual funds.

Debt and Equity Markets

Before understanding the difference among different investment types, it is important to know the difference between debt and equity markets. The debt market is where debt instruments are traded. These include bonds and mortgages. The equity market is where equity instruments are traded. An example of an equity instrument is stock shares like those traded on the New York Stock Exchange.

Difference Between Debt and Equity Instruments

Equity financing allows a company to make investments, such as in new equipment or product development. People or organizations that purchase stocks gain ownership in the firm and also have a claim against future earnings. These are distributed as dividends, which change depending on how the company is doing financially. The value of a share of stock rises and falls depending on how the company is doing financially, how the economy is faring and other criteria. A stockholder can sell his shares on the stock exchange for a profit or a loss. With bonds, the borrower's only obligation to the bondholder is to repay the loan with interest. For an investor, purchasing a bond means a fixed rate of return, a predictable source of income. Bonds are purchased by investors on the debt markets and the purchase price may be higher or lower than the face value of the bond. Like stock purchases, the purchase price depends on how the company is doing and other factors.

Mutual Funds

As you plan your own investment portfolio, you will most likely come across mutual funds. These funds are operated by an investment company which raises money from shareholders and invests in a group of assets. Mutual funds may be stock mutual funds, bond mutual funds or a combination of the two. The appeal of mutual funds is the diversification they typically offer across a wide range of companies and investment types. Mutual funds are managed by professional money managers. Many company retirement plans are invested in mutual funds.

Investments Outside Your Retirement Accounts

You also may want to invest some of your own money outside of your company savings and retirement plans. Financial planners advise starting with a small amount and adding funds as you get a better feel for investing and the amount of risk you are willing to assume. Professional money managers are available to help you decide how to invest your money.

the nest