If you’re wondering what the differences are among various investment options such as Stocks, Bonds, and Pooled Funds, here’s a short and easy primer for you.
If you want a more detailed discussion of these investment products, head over to our article on Time deposits, stocks, bonds, mutual funds, real estate: Where to invest my money?.
Bonds (or Debt Instruments)
When the government or a corporation needs to raise cash, it may borrow from investors.
When they borrow money, they have to issue a debt instrument, usually called a Bond. A bond is proof of a company’s obligation to pay and entitles the bondholder a fixed rate of return paid at predetermined times in the future.
Governments also borrow, and the instruments they issue include treasury bills, treasury bonds, and notes.
Since government debt is more or less guaranteed, the interest or coupon rate of a government is usually lower than a corporate bond because of the lower risk of payment default.
A stock is a unit of ownership in a corporation. Thus, when an investor purchases a stock of a company, he or she becomes a part-owner of the entire company. As part-owner, the investor can vote on corporate matters and receive dividends from the company’s earnings.
Dividends are payments to investors representing their share in the company’s income. Unlike interest payments in Bonds, dividends are not guaranteed and must first be declared by the company before these are distributed. During times when the company’s earnings are falling, it may decide not to pay a dividend.
However as part-owner, the shareholder is entitled to the residual income generated by the company. In case of liquidation, the shareholder gets to receive his or her share of what’s left in the company once all creditors and other obligations have been paid.
A pooled fund is an investment fund that gathers money from various investors and invests it collectively. The fund is handled by a portfolio manager who invests the money in a portfolio of securities and/or other instruments that could include bonds or stocks, among others.
A fund offers several distinct benefits to investors:
- As a single investor, it may be difficult to achieve diversification. Funds enable you to purchase various types of securities and other instruments to build a diversified portfolio.
- The fund is managed by experienced professionals who have access to information on the economy and market movements.
- Through the fund, you can invest in a diversified portfolio, enjoying the same earnings potential from the securities that would have been accessible exclusively to institutional investors.
- Funds make it possible for investors to buy instruments at a lower cost. When the fund buys different instruments, the cost of buying these instruments is divided among all investors versus the sole investor bearing the total cost.
Other must-read posts that you’ll surely find interesting:
- Should I invest in Preferred Stocks?
- Investment Objectives: Capital Appreciation, Preservation, Current Income, Total Return?
- Relationship between interest rates and inflation