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The Difference Between Stocks, Bonds & Mutual Funds

There are so many complex issues and constant change in our business of financial planning and investment management, that we often forget some of the basic questions that many people have, such as what a Stock, Bond or Mutual Fund is? I will attempt to answer these questions at a very basic level below.

A share of stock is, at its most basic level, the representation of ownership of a corporation that is a claim on the corporation's earnings and assets. There are several different types of stock shares. Common Stock usually entitles the shareholder to vote in the election of directors and other matters taken up at shareholder meetings or by proxy. Preferred stock generally does not confer voting rights but it has a prior claim on assets and earnings -- dividends, which are the distribution of company earnings to shareholders, must be paid on preferred stock before any can be paid on common stock. In addition, a corporation can authorize additional classes of stock, each with its own set of contractual rights. Shares of stock may be privately or publicly held. Publicly held shares must go through a regulated registration and underwriting process and can then be purchased and traded by the public. Investors make money investing in stocks by collecting or reinvesting any dividends issued by the corporation, and if the share price appreciates to more than the price they paid for the shares. They will lose money if the share price of the stock depreciates lower than the cost at which they purchased it plus any dividends received.

A bond, at its most basic level, is a loan between an entity such as governments and corporations and an investor who purchased the bond.  A bond can be any interest-bearing or discounted (which means that the investor would pay less for the bond today and receive a greater amount when the bond issuing entity pays off the loan) security that obligates the issuer to pay the bondholder a specified sum of money, usually at specific intervals, and to repay the principal amount of the loan at maturity. Bond holders have an IOU from the issuer, but no ownership privileges, as stockholders do. Investors make money on a bond investment by collecting the interest and holding the bond to maturity or selling the bond prior to maturity for a price which is greater than what they paid for the bond originally.

A mutual fund is operated by an investment company that raises money from shareholders and invest it in multiple securities such as stocks, bonds, options, futures, currencies, or money market securities. These funds offer the investor diversification and professional money management for a fee. Mutual funds come in many different varieties. Some invest aggressively for capital appreciation, while other are conservative and are designed to generate income for shareholders.

Investors need to assess their tolerance for risk before they decide which stock, bond or mutual fund would be appropriate for them. In addition, the timing of buying or selling these securities depends on the economy, the state of the stock and bond markets, interest rates and other factors and past performance is no guarantee of future results.

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