Basics of Stocks and Bonds

Every dollar well invested, after careful study, is going to be worth more than a dollar eventually. If you have decided to put a quantum of your savings to good use, two prime investment options, which you should think about are stocks and bonds. Both investments come with a substantial degree of risk compared to others, but they also have a proven track record of generating the highest amount of returns. In this Buzzle article, I shall introduce you to the basics of stocks and bonds, which every beginner investor should know about.

Basics of Stocks and Bonds

A security is any kind of financial instrument with a monetary value. Both stocks and bonds are securities which you may invest in. Both of them differ substantially in their earning potential and nature as financial instruments. The common factor is the fact that both of them are traded openly in markets, where they can be bought and sold to make profits. Here are the basics of stock and bond investing.

Stock Basics
When you buy a stock of any company listed on the stock exchange, you purchase a fractional ownership of the company. In financial terms, a stock purchase equals buying 'equity' in a company. To raise funds, businesses sell a substantial part of their ownership in a company through a stock market (Initial Public Offering) IPO process. A stock is basically a certificate that grants you partial ownership in a company and it has a value, which is a function of the company's performance. Stocks are bought and sold in the stock exchange and their value fluctuates according to the performance of the business.

The stockholders may or may not be granted dividends, which are profit shares distributed by the company. Stocks are either 'common' or 'preferred'. Preferred stocks don't grant owners any voting rights but people who own them are given first preference when distributing dividends. Common stockholders have voting rights that may influence company decisions. The only important parameter which you need to know about a stock is its current trade value.

The key to make profits in stock investing is picking stocks of companies with potential and holding on to them, until you think their true value has been realized. 'Buy cheap and sell dear' is a simple mantra you need to follow. Making profits here requires a thorough knowledge of industrial sectors in which you plan to invest and a good sense of timing, which guides you when it's time to sell or buy a stock. To understand stock investing, one book that I highly recommend is 'Intelligent Investor' by Benjamin Graham. For more, check out this article which presents stock market investing for dummies.

Bond Basics
Unlike stocks, purchasing a bond, doesn't make you a partial owner in a company. It makes you a creditor of the company, as buying a bond is loaning money to the business entity which issues it. A bond is essentially a loan agreement between you and the issuing company that promises you a fixed percentage of returns on the principal invested value, which is paid after a fixed amount of time. The 'face value' of a bond is the issuing cost of the bond, which is equal to the 'principal', that you invest through the bond.

The 'coupon' is the yearly interest paid by the company to you as the bond owner and the maturity period is the amount of time after which you will be paid back, with the principal value of the bond, plus interest. Bonds may be traded at a price which is higher than their face value in secondary markets. Like stocks, to make profits, bonds must be bought cheap and sold dear, within the maturity period.

This concludes our short discussion on the basics of stocks and bonds for beginner investors. As most expert investors who have weathered Wallstreet ups and downs for years, will tell you, don't base your investment decisions in stocks and bonds on pure speculation or emotions. Create a sound logical framework and let the numbers in the company balance sheets be your guide, instead of rumors and promises. Study of the developments in the core sector, where you plan to invest is vital to make sound investment decisions. Two good rules to follow are - 'Don't invest in what you don't understand' and 'Keep it simple'. Here's me signing out, while wishing you all the very best in your stock and bond investing endeavors!