The equity market provides investors multiple ways to invest in publicly traded companies. Investors can buy and sell shares of an individual company’s stock, trade a collection of companies or industries through ETFs and mutual funds, and invest in companies and governments with bonds.
Stocks
Stocks are shares of a company issued to generate capital for the corporation. Investors that purchase stock acquire an ownership stake in the company based on the number of shares they purchase. There are two types of stock: common and preferred. Investors purchase shares of a stock when they believe the company’s value will increase in the future.
Holders of common stock, called shareholders, own a portion of the company and have voting rights on corporate issues such as appointing members to the board of directors and takeover bids. Because of the voting rights of common stock, shareholders essentially control the business. Common stockholders may also receive dividends from the company.
Shares of common stock are issued in the primary market through an initial public offering (IPO) and then trade in the secondary market, typically on a stock exchange, through an intermediary known as a brokerage firm. Common stock is bought and sold on exchanges such as the NYSE or the NASDAQ, and these exchanges provide real-time pricing on the value of a company.
Common stock is generally referred to as a liquid investment because stockholders can liquidate their shares readily at market prices. Companies issue a finite amount of shares during their IPO and may issue more shares to raise additional capital later. The value, or market capitalization, of a company is found by multiplying the shares outstanding by the current stock price. Stock prices fluctuate continuously as investors evaluate the perceived future value of a company.
ETFs
ETFs (Exchange-Traded Funds) are a basket of securities like stocks, bonds, and commodities packaged together and traded on an exchange. ETFs typically represent an index or sector and are created by bundling together multiple securities into one tradable asset.
ETFs are bought and sold through brokerage firms during market hours, much like stocks. Unlike stocks, ETFs do not grant ownership to any of the underlying assets within the fund. Instead, the ETF tracks the overall performance of the combination of assets.
The amount of shares of the underlying security owned by the fund determines how much of the overall percentage of the ETF is invested in each individual security. In contrast to mutual fund shares, ETFs may be bought or sold at any time during market hours. ETFs are typically open-ended, and the fund’s management may create more shares as warranted by investor demand.
Mutual funds
Mutual funds collect money from multiple investors and combine them to purchase securities such as stocks, ETFs, and bonds. Investors can buy shares of a mutual fund much like a stock but receive no ownership of the mutual fund. A mutual fund’s value is equivalent to the performance of the underlying assets owned and is tracked similarly to a stock.
The holdings in mutual funds are not actively managed by the individual investor. Instead, one or more money managers oversee the investments and make decisions on how and where to allocate the investors’ money.
The price of shares in a mutual fund are not calculated until after-hours, so, unlike stocks and ETFs, mutual funds cannot be traded during regular market hours.
Bond funds
A bond is a fixed-income security that acts as a loan between an investor and a borrower. Bonds are interest-bearing or discounted government or corporation issued securities where a specified amount is borrowed and then repaid at maturity. Borrowers are typically companies or governments looking to raise money from investors in exchange for agreeing to pay back the loan in a specific time period at a predetermined or variable interest rate.
Bonds are fixed-income securities because they provide payment to the lender, with interest, for the duration of the bond. Bonds have a maturity date when the borrower must repay the lender the principal amount in full; if they do not, the bond will default, and the lender will no longer receive payments. This is why less creditworthy, riskier bonds typically yield a higher interest rate because the lender is being compensated for their level of risk.
The terms of the bond, such as maturity date and coupon rate, are stated in the bond indenture and represent a formal agreement between the lender and borrower.
Bond funds are a specific type of ETF or mutual fund that pool investor funds to purchase bonds. Bond funds pay interest on a monthly or quarterly basis. Bond funds are typically incorporated in investor portfolios that are seeking diversification, current income from interest payments, or a combination of objectives.
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