Stocks, bonds, mutual funds, and ETFs: What's the difference between these common investment types?

You’ve probably heard of stocks, bonds, ETFs, and mutual funds. But do you know the differences? Learning the differences can help you decide what mix of investments might help you reach your goals. Here is a quick, no-nonsense guide to common investment types

Stocks let you own a piece of a company’s future. When a company needs to raise money to help pay for expenses, such as hiring more people and expanding into new markets, they issue “shares of stock.” The value of your stock will go up or down based on several factors, but ultimately depends on how the company performs financially in today’s market. Stocks can help you diversify your investments. But it’s worth noting that stocks are considered high-risk investments since there’s no guarantee that the stock will increase in value.

Bonds, also known as fixed-income investments, are “debt investments.” Bonds represent money loaned to companies or governments. When you purchase a bond, you are basically loaning money and are paid interest based on the value of the loan. The issuer of the bond pays back the principal (the loan amount) plus interest over a specified time frame. Interest is known as the “income” in fixed income. When the bond “matures” at the end of the period, the issuer pays back the full amount borrowed. Most bonds are designed to pay you a steady income on a regular basis.   Bonds do run the risk of default, or not paying the principal back to the lender.

Mutual funds are “baskets of investments,” chosen and managed by professionals. With mutual funds, you don’t directly own individual stocks or bonds. Instead, you own shares of the fund (which owns the individual securities). You can invest in one mutual fund made up of diverse assets from different segments of the market, such as large cap growth, or industries, such as technology.   Mutual funds help to diversify your investments. Some mutual funds even hold a mix of stocks and bonds, offering a diverse portfolio in one fund.   These are often called balanced funds.

Mutual fund managers are responsible for implementing the fund’s investment objective as stated in the prospectus by actively monitoring and trading the portfolio as they seek to maximize returns.   For this service mutual funds charge an expense ratio, which comes out of your investment.[DA(1]   Mutual fund orders can be submitted throughout the trading day, but unlike stocks or ETF’s, they are executed once a day and priced after the market closes. They also usually require a minimum dollar investment amount.

Like mutual funds, ETFs are “baskets” of securities that can include assets such as stocks, bonds, commodities, and other assets  pooled into one fund. Many ETFs are built to follow market indexes (before expenses). These ETFs are called index funds. They simply buy and hold whatever is in the index and make no active trading decisions.  Other ETFs are actively-managed and seek to achieve a stated investment strategy.  Unlike mutual funds, ETFs are transacted and priced throughout the day akin to a common stock. Thanks to their potential built-in diversification benefits, as well as their comparatively low costs and potential tax advantages, ETFs are a popular investment choice.

Active vs. passive management: Actively managed funds generally try to outperform a market index or other benchmark. Passively managed funds typically seek to track the returns of a market index, prior to expenses.