Have you ever had a conversation with someone who is an expert in a certain area? It could have been meeting with your CPA to go over your taxes or talking with your real estate agent during a house hunt. Experts tend to use a lot of professional jargon. Most of them don’t realize that you may not understand. They get caught up in the conversation and you keep nodding because you are afraid of them thinking you are dumb. Unfortunately, some professionals know this and they will use jargon to make themselves sound smart. Investment professionals are particularly bad when it comes to making sure clients understand. So, I am going to have a series of blog posts called Investing Basics designed to explain different investment options.
There are many different investments available, but I am going to start by covering the two most common forms. These are stocks and bonds. Many people in the US only invest in these two options. If you participate in an employee retirement plan, then you definitely own at least one of these. Now the question is, “What the heck are stocks and bonds?”.
Stocks (also referred to as “shares”) are partial ownership of a company. Most companies issue stock in order to raise money and grow business operations. The stocks can then be bought and sold by anyone in the world. People buy stocks because they expect a company to make money in the future which will cause the value of their stock to rise. Stocks can also pay dividends to their shareholders, something that I will explain in more detail in a later post. Example: If I purchase one share of Apple stock, I am about a 0.00000001% owner of the company.
Bonds represent debt of a company or government entity (Federal, states, and cities). They issue bonds and promise to pay buyers interest over the life of the bond. Corporations will prefer to issue bonds when they do not want to give away more ownership in their company. They receive the money now, but are required to pay it back over a set period of time. People invest in bonds because they receive a set interest rate that they will be paid over time. Example: The State of Missouri wants to raise money for a construction project. They issue 10 year bonds at a 3% interest rate. I buy a bond for $1,000 so I would get paid $30 each year for 10 years and then receive my $1,000 at the end of the 10th year.
Stocks and bonds will probably be the majority of your investments throughout your life, but most people own them through a mutual fund. A mutual fund is essentially a group of stocks and/or bonds that is managed by a professional company. I will explain more about those in the future as well.
Now you know! I don’t think this will change how you invest, but I do want you to understand what these investments represent. And next time you laugh at the People of Walmart blog, just remember that you are probably a tiny owner if you have an investment account. That shopper may not be wearing a shirt, but hopefully they spend a lot of money.
Mike Zeiter, CPA/PFS