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There are 3 basic instruments when it comes to invesments. On which instrument to invest depends on your investment goals and risk appetite. You need to understand the behavior of each instrument in order to manage your expectations on investment returns and risk.
I have lots of friends who want to know more about these instruments but never could find something online that's easy to understand. And these friends of mine don't have a Finance background so I try to explain these terms in the simplest way I could without being too technical.
Bonds - lending money to the governemnt or corporation for a fixed time and interest rate.
That's right, it's you lending these big entities money. Why would they ask for your money? Because it would cost them more to borrow from a bank. So instead of borrowing money from a bank that usually has high interest rates, they borrow money from you through bonds. With bonds, they can dictate the interest rate and the duration of the bond and thus they have more control on their costs.
Returns from bonds are fixed since there is a predetermined interest rate.
Investment Goal: Income Generation, Capital Preservation
Income: Interest Income
Examples: Goverment bonds/T-bills, Corporate Bonds
Also referred as: Fixed Income Securities
Risk: Virtually Risk Free to Low Risk
Stocks - buying ownership of a corporation.
A company can be owned by many people. They get ownership through buying stocks. The more stocks you have, the more ownership you have. People who have a significant number of stocks are what we call major stockholders. Usually, if you have more stocks then you have more voting power regarding major decisions of the company.
You earn two ways in investing in stocks. One is through dividends. At the end of the year, if the company has excess earnings, it may declare giving dividends to stockholders. Think of dividends as your share in the company's profits. The more stocks you have, the more share in the earnings you get. Declaration of dividends is not fixed though. A company is not obliged to declare dividends every year. A company may not declare dividends due low earnings or tight cash budget.
The other way to earn from stocks is through capital appreciation. If a company is projected to do well, earn more profits due to an expansion program, then there's higher chance of declaring dividends. People would then want to get hold of this stock, thus increases demand, in turn increases price.
Returns from stocks are volatile. There is no guarantee on returns but returns can be potentially big like 100% return r even higher. However, it can easily go the other way, you can also incur equally big losses.
Investment Goal: Capital Appreciation
Income: Capital Appreciation and Dividends
Also referred as: known as Equities, Shares
Risk: High Risk
Mutal Funds - giving your money to an investment house for them to manage your money for you.
Not all folks have the time to manage their own money. Investing stocks on your own takes time and effort to study the market, the companies, their individual stock performances. With a mutual fund, an investment house does the investing for you. In turn they charge you with management fees. You, as an investor get to dictate which underlying asset you want them to invest your money into - stocks, bonds, or balanced (both stocks and bonds). This is the only decision required from you, everything else will be done by the investment house. For example, if you choose stocks as your underlying investment, then the investment house will be the one to decide which stocks to buy, when to buy, and when to sell. As such, mutual funds are quite passive investments since there is very little to no participation needed from you.
Returns reflect the returns of the underlying asset.
Investment Goal: Same as underlying asset
Income: Same as underlying asset
Examples: Sun Life Prosperity Funds, Philam Strategic Growth Fund, ALFM Growth Fund
Risk: Same as underlying asset
So what do you think is the best investment for you?
Personal Thoughts:
I personally prefer stock mutual funds. I prefer mutual funds since I don’t have the capacity and expertise to manage my investments on my own. I choose stocks as my underlying asset because I accept absorbing risk in exchange for potential higher returns. I can accept risk as of the moment since I don’t have any dependents and no debts so there is no problem with volatile and non-guaranteed returns.
