Investing for beginners stocks and b

Investing for beginners “stocks and bonds”   by sandeep khara

in Investment    (submitted 2008-03-21)

Stocks and Bonds

Why does investing seem so complicated?

The number of ways you can invest is mind boggling. The worst part is that investment world uses a different terminology. If you are new to investing it won’t be long before you encounter words like “accretion, moving averages,amortization,average weighted price, open interest, futures and option, book closure” etc. Let me stop before I put you to sleep. All you really want to do is to put your money in something where it will be safe and grow. Is that too much to ask for?

Why are there so many different investing alternatives?

Are they really different! If you have ever been to a grocery store you will see boxes of different detergents, most of which will be labeled “new!” “Improved!” or even better “New and Improved!” But no matter what they call it, when its all said and done these boxes are filled with nothing more than SOAP, same as they have always been.

Investments are no different. At first glance it may appear that all these mutual funds, unit trust, REIT’s, options, futures are unique and require encyclopedic knowledge to understand the technicalities. But more often than not what you are looking at is nothing more than just an old way of investing in a new box.

Understanding investing in simple terms:

In a family tree you will have a male and a female at top of the list from where all the other branches came out. Similarly in investments at the top you have stock and bond. All other forms of investments are some form or other of these two. And their differences can be spotted just as easily as you can distinguish a man from a woman.

What are stocks and bonds and what is the difference between the two?

I will compare stocks to a racing car; all powerful snazzy, attractive, dangerous, accident prone and bonds to the family car; nothing much to look at, slow, always takes you where you are going, always there for you.

Some basic traits of the two:

People investing in stocks want to see a return on their money, bond holders want to make sure the return of their money.

Stocks are about taking risk and bonds are about avoiding risk.

Stocks offer unlimited upside potential, bonds offer limited downside potential.

Stocks mean ownership and bonds denote loaning. So we can say one is an ownership investment and the other is a loan investment.

The difference between an ownership investment and a loan investment is not too hard to understand. The differences are obvious once you know what to look for.

An ownership investment does not have an ending date. (When you buy a stock it never becomes due, you have to sell it to get cash)

Loan investments almost always have a due date (e.g. your fixed deposits with the bank)

Ownership investments rarely promise a specific return. A stock price can go up 10 times or remain static for years.

Loan investments nearly always promise a fixed return. A six month deposit certificate promises 4% return.

Third major distinction is whether you will get your money back.

In ownership investment there might be no such guaranty. A stock’s price can go to zero.

The loan investments are usually backed by the guaranty of the bank or the government.

With the above distinctions in your mind try to figure out what you are invested in.

Few examples: your checking account or Government bonds: loan investment

stock or mutual fund: ownership investment

What should I invest in?

Having too much investment in one type can be bad for the investor. Loan investments are unable to keep pace with inflation, you might have your money safe but the purchasing power goes down. Too much risk avoidance will result in less return. Similarly Ownership investments can leave you without a penny in your pocket. Idea is to keep a balance between the two. Neither is in a category of good or bad or one better than the other investment rather they serve different needs. Needs which can vary from one person to the other depending on ones investment time horizon and risk appetite. Stocks and bonds complement each other.

In case you are new to investing first check your risk appetite, needs and time horizon of investments to decide where you should put your money. I would suggest that you read more about stocks, mutual funds and bonds in following articles.