Simply put, stocks and bonds are ways for companies to raise money. Companies like to raise money when they have several profitable business ideas, but only have so much money in their bank account.
So how exactly do stocks and bonds help companies raise money? Well, they each do it a little bit differently.
You raise money with stock by selling part of your company. With bonds, your company borrows the money and promises to make interest payments.
What is Stock?
Stock is a financial security that represents an ownership share in a company. That means if you own stock in a company, then technically you own part of that company.
What’s does ownership in a company mean for you?
Well it means that you own part of all the buildings, equipment, inventory, etc. that the company owns. I mean, that’s pretty cool. But what’s even better is that you’re entitled to a portion of all the profits.
All these profits will either be paid out to you (in cash!) every 3 months or reinvested back into the company (which will make your stock worth even more!).
So yeah, if you own stock in a company, then you literally own part of the company.
If a company wants to raise more money, then a way to do that is to sell stock (all the future earnings). Some people are willing to pay a lot of money for that. But understand that you can only do this for so long because at some point 100% of your company will be owned by the public.
What is a Bond?
A bond is a special loan that companies can get. Except they don’t have to ask a bank for this type of loan. They can ask the public.
What happens is that a company, normally with a good reputation, will issue what’s called a bond. The public will usually buy these bonds for (usually) $1,000 each.
But what does this $1,000 get you? Well since you were nice enough to loan the company $1,000, they will pay you interest twice a year for however long the bond is set for (usually 3-10 years).
And here’s the best part: At the end of bond’s life, the company is going to give you your $1,000 back!
Pretty sweet deal if you ask me. But only if you trust that the company is in a good enough position to not go bankrupt.
If a company wants to raise money but doesn’t want to sell stock (or doesn’t have any stock left to sell) then they can just borrow the money via bonds.
Benefits and Drawbacks of Stocks and Bonds
I know what you’re thinking right now: “Wow, investing is so cool. Both stocks and bonds are perfect for everybody and there are no drawbacks to either of them.”
Unfortunately, that’s not the case.
A big benefit to stocks is that, historically speaking, buying stock and owning a share of the profits of companies has provided a much better return on your money than bonds. That’s to say, if you invested $1,000 in various stocks and $1,000 in various bonds, the stocks are going to be worth $2,000 a lot sooner than the bonds.
But if stocks make more money, then why would anybody invest in bonds?
That’s a great question and I’m glad you asked!
People invest in bonds, even though the generally have a lower return, because they are considered safer investments. Why are they considered safer?
That’s because in the event a company goes bankrupt, they must sell everything they own and pay back the bondholders. If there’s any cash left after that then it’s distributed equally to all the stockholders.
That means bondholders are pretty much guaranteed to never lose all their money. But stockholders are always risking that chance.
So, there you have it. A simple breakdown of stocks and bonds. You can see how each one of these financial instruments can help a company raise money, and also how they can make an investor money.
An investor can buy stock and then sit back while the profits roll into their bank account for years to come. Or they could buy bonds, effectively loaning their money to companies and being paid interest the entire time.
Both stocks and bonds have their benefits and drawbacks. Each one presents a unique opportunity to take your money and turn it into more money.
And remember, you don’t need a financial advisor to buy stocks and bonds. You can start in less than 10 minutes by heading over to my tutorial. Happy investing!