We will touch on stocks first because they are the primary piece of many other investments. Stocks are, in essence, ownership in a company. When a company becomes publicly traded they release stock which represents a portion of the company.
Stocks will go up or down based on the demand for the stock. It is conceivable that a stock price could go up as a company does bad. However, this is not likely as many stocks produce income based on company profits. That being said, it is demand that creates a stocks price.
When looking at a stock we have to look at its overall features.
- Risk – The first thing to be aware of with a stock is risk. Stocks have 100 percent risk, meaning you can lose all of your money. There are no inherit features that make a stock less risky, unless you buy other stocks or other options to hedge, or reduce, your stock risk.
- Liquidity – Stocks are, for the most part, liquid. You can easily sell your stocks whenever you want, at least currently. Our stock market system means there is probably someone willing to buy if you are willing to sell. The price may not be what you want when you decide to sell, but for the most part stocks are a liquid asset.
- Taxes – Stocks are taxed differently depending on how long you hold them. However, stocks are taxable and when you sell there will be a tax associated.
Bonds, unlike stocks, are based on, basically, a massive loan. A company or government will need money so they will issue bonds that pay out over a period of time at a certain interest rate. This makes them less risky than stocks.
- Risk – Because bonds are tied to an interest rate they are less risky. You are guaranteed, at least, that interest rate attached to the bond. However, because of fluctuating interest rates a bond could lose value, so there is still risk in buying bonds although not as much.
- Liquidity – Bonds are, for the most part, liquid–in the sense that you can sell your bond on the market. However, if you are forced to sell a bond you could still lose money that you expected to gain. Bonds are pretty simple to liquidate so if you need money you can get it from your bonds.
- Taxes – There are different types of bonds. Regular bonds are taxed, other types of bonds are tax advantaged, or are tax-free. There is a difference, however, most bonds, beside municipal bonds, are taxed at investment rates.
Mutual funds are their own beast. A mutual fund is run by an manager who buys and sells stocks. The manager will choose what to buy and sell based on what they think is best for the fund. Different funds operate on different principles.
- Risk – Because mutual funds are just a conglomerate of stocks they are still 100 percent at risk. However, because they are diversified there is a less chance of having a major loss. If the entire market turns then the mutual fund will most likely drop, however, individual stock changes will have less of an overall effect on the mutual fund itself.
- Liquidity – Mutual funds themselves are liquid. You can buy and sell them as you please.
- Taxes – Mutual funds are taxed the same as stocks.