Bonds Vs Stocks Vs Mutual Funds – which investment is better for you?
All our lives, we’ve heard about investing and how it can compound our money.
Although it’s recommended by many, a lot of people still shy away from investing.
They do so because they see investments as risky. Although they are partially correct, I really believe that scared money doesn’t make money.
Any investment will always carry some type of risk. So to know more about different investments that you can do, I’ll be writing the difference between stocks vs mutual funds vs bonds.
These are the most popular investments out there! ??
Bonds Vs Stocks Vs Mutual Funds – Which One Is The Best For You?
Bonds, stocks, and mutual funds are the safest investments out there because they are regulated by legitimate organizations.
The Securities And Exchange Commission or the SEC is the one who regulates and makes the rules in the US financial markets.
When it comes to investing, we always think about the stock market immediately – not knowing the other two investments. So to start, let’s take a look at bonds first.
Investing In Bonds
Bonds are issued by corporations, governments, and states or cities. A bond represents a loan.
Why are bonds made?
Bonds are used by parties above because they need funding for their projects and operations.
The details of a bond include the date when the investor will be paid and the interest that comes with it.
Companies make bonds because sometimes the bank can’t provide the full amount of loan that the company needs, so they turn to investors to loan them money.
Cities, states, and governments issue bonds when they need funding for road projects, construction of parks, etc.
How bonds work:
For example, Company TMG needs money to expand its operations overseas. They don’t want to borrow from banks, instead, they want to loan from investors.
Since Company TMG found people to borrow money from, they issue bonds with the full details.
Below are details that investors look at bonds:
1. Face value – This is the bond’s price when it was first issued.
2. Coupon rate – This refers to the rate of interest that the issuer will pay the investor come the maturity date of the bond.
If Company TMG releases a 3-year bond with a face value of $1,000 that has an annual coupon rate of 5%, the investor of that bond will receive $50 every year until the bond matures.
3. Maturity date – This is the date when the investor is paid with his final interest payment and the principal amount of his investment. This is also when the bond issuer fulfills its debt-obligation to the investor.
4. Bond-rating – Bonds receive a rating from bond rating agencies. The rating tells you how risky a bond is.
The low-risk bonds or top-rated bonds have a rating of AAA (triple-A) or AA (double-A). Bonds that are rated A and BBB are medium quality and bonds that have below BBB rating are considered low quality or junk bonds.
When it comes to bonds, the higher the risk, the higher the returns. So those triple and double A’s might be safer but they give out a lower return on investment.
Investors look at the maturity date of a bond because the longer this is, the higher the risk of the bond. Why? Because during that time, the institution or the bond issuer might go default and won’t be able to pay back the investor.
Since that can be a possibility, there’s something we call secure and unsecured bonds.
Basically, an unsecured bond means you may lose all your investments if the company isn’t able to pay back the loan. A secured bond has an agreement that if they can’t pay the loan, they pledge to give assets to their bondholders.
To go deeper into this subject, let’s discuss the different types of it.
Corporate Bonds – These are bonds issued by private and public companies. These types of bonds usually carry a higher risk which means they give out a higher return on investment.
Treasury Bonds – These are issued by the US department of treasury on behalf of the federal government. The bonds here have maturity dates that range from a month to 30 years. There’s little risk of defaulting because it’s backed by the US government.
Municipal Bonds – Issued by states and local governments to fund road projects, schools, housing, sewer systems, and other things that can improve their state.
Investing In Mutual Funds
A mutual fund is a pool of money from different investors.
This is the type of investment that you choose if you want a stress free way of participating in the financial markets.
If people don’t take on this route of investing, they are the one’s who manually buy the shares of a company. This process can sometimes be tedious since you need to study the companies that you’re investing in.
Plus, sometimes it can be costly. Just look at the share price of Amazon below.
A single share costs you $3,297.37.
This is where a mutual fund comes in handy. With a $3,000 capital, it’s more than the minimum investment needed for mutual funds.
A mutual fund isn’t just focused on a single stock, there’s a fund manager that usually spreads out the fund to have diversity and lessen the risk involved.
Some mutual funds just focus on stocks, while others are spread out in the bond market, and other mutual funds invest in both.
Since you don’t get to pick the stocks that you’ll be investing in, what you can decide on is the type of mutual funds that you’ll be joining.
Types of mutual funds:
Equity funds – This type of fund is focused on buying stocks in the market. They have more growth in value but also brings a little bit of volatility in the portfolio.
According to Ontario Secured Securities, you can choose an equity fund that specializes in growth stocks, value stocks, large, mid, and small caps. There’s also a fund that has a mixture of all of those.
Bond funds – As the name suggests, this mutual fund is invested in bonds. This fund invests in corporate or government debt because it’s much more “safer” and has less volatility. But an important factor to consider is that since it’s safer, it has less growth potential.
Balanced funds – This fund is spread out to different investments like stocks and bonds. The fund manager here tries to balance the fund to achieve high returns for the inventors.
Index funds – This fund follows the movement of a stock market index. So if the stock market is going up then most definitely this fund is up as well.
Benefits of a mutual fund:
Diversification – It’s always recommended to have a diversified portfolio for the simple reason of volatility and risk.
If you are fully invested in a certain sector and that sector collapses, your portfolio will surely go down in value. As compared if your portfolio is only 5% in that sector, it wouldn’t take that much damage.
Handled by professionals – As mentioned earlier, a fund manager gets to decide where to place that pooled money.
You don’t have to suffer from newbie mistakes and going through the process of understanding financial statements and reading charts.
But just like any investments, there will always be issues or downside to it.
In a mutual fund, most people shun the idea of investing in it because of the fees. To know more about mutual fund fees, I highly suggest reading my post on What To Invest In Your 20s – there I talked about mutual fund fees and where you can find them! So peep that article out and let me know what you think 😉
Investing In Stocks
Investing in the stock market is the most common investment out there. And probably the most appealing…for me?
It may not be the safest among its peers but it gives out great returns.
You can invest in the stock market via a mutual fund or you buy the shares on your own.
Sometimes it’s much more fun to do it on your own because you get to learn more things about a company and you also learn new skills (reading charts and financial statements).
When you’re invested in a company, you’re already a part-owner/shareholder of that business.
If the business earns that year and its stock prices go up, you gain money too. But if it’s a bad year for the company, then you might see your investment go down.
The US stock market has been rising for a decade. In fact, the US market had the longest-running bull market in history – this means that it constantly went up! The bull run started in 2009 and ended in 2019.
The main way to make money in the stock market is to sell a stock at a higher price than when you bought it.
Although it sounds simple, it’s always easier said than done. There are many strategies to buy and sell a stock, but that’s another topic for trading. We’ll solely focus on investing in this post.
Approaches to stock investing:
Generally, there are two approaches to investing in stocks – finding growth stocks or value stocks.
Growth and value stocks are fundamental approaches in individual investing and mutual fund investing. Let’s discuss them one by one:
Growth stocks – These are stocks that show above-average earnings compared to its peers and sector.
This is appealing to investors because these companies have more room to grow and might set out to be as an industry leader.
That opinion is just mere speculation but I’m sure when professional money managers think that a stock is a growth stock, they can back it up by data and research.
Growth stocks don’t usually pay out dividends because their earnings are invested back to the company.
Investors in these stocks don’t expect to receive dividends but they expect to earn money as the price of the stock increases over time.
Value stocks – These are stocks that are trading below its current fundamentals. If these companies earn money, they usually give out dividends to their investors.
Investors in these stocks believe that since there is a mispricing in the company’s fundamentals and stock price, eventually the stock price will catch up to the company’s real value.
For example, a value investor looks at the financial statement of Apple, in his calculation derived from different financial models, Apple should be trading at $700 per share as compared to its current stock price which is around $470 per share. So that difference is the mispricing. It’s what determines if a stock is good for investing.
Which one is better?
No one can know for sure which group of stocks are better. Some studies show that value stocks outperform growth stocks and vice versa. It can be different from time to time because of the different factors involved.
So what investors do instead is be invested in both groups of stocks. They have money on growth stocks and also have a percentage of money allocated to value stocks.
Bonds Vs Stocks Vs Mutual Funds
When it comes to risk-averse people they will typically choose bonds over stocks because companies are required by law to pay first the bond investors before the stock investors.
Plus the chance of a company getting bankrupt is higher compared to government and states.
That’s why bond investors are usually people who are nearing retirement. These are people who can’t take big financial damage in their life because they’re almost up for retirement.
Stocks on the other hand bring more volatility to the portfolio but give out way better returns.
I actually prefer stocks over bonds. Not only do I get a chance for better ROI but I also get to be investing in companies that I like and use.
According to Covenant Wealth Advisors, when choosing the right investment, there are four criteria that you should look at:
1. Age – Since the younger generation has more years ahead of them, they can afford to see their investments go down for a while (if it does), with this, stocks and mutual funds can be a great avenue for them to build wealth on the side.
2. Holding Period – According to the site, if you’re planning to hold an investment for less than 5 years, bonds is the way to go and mutual funds that focus on that asset class.
I also believe in this too. 5 years is a short time when talking about long term investing in the stock market. You might not be able to maximize gains in that time period.
3. Income Generation – They suggest that bond and dividend stocks are the way to go when you’re building a retirement portfolio.
But for me, if you’re still young and you’re already thinking of a retirement fund, you can still afford the market volatility in your portfolio because you’re timeframe can be around 10-20 years.
4. Risk Tolerance – To be honest, investment decision usually boils down to this criteria.
You might have a 5-year plan but if you’re willing to risk that money to achieve higher returns (but still minding the risk), you still might choose stocks over bonds.
Don’t let all this information go to waste. Some just read and let valuable information just pass by them. Be proactive! Let this post be your introduction to these investments. Then go deeper into learning more about them.
Once you’ve done your research, make sure to follow up on it by making an account and investing in your choice of asset class. Don’t get stuck on analysis paralysis, just do it!