Stocks, Bonds, and Funds -- A Plain English Overview

What Stocks Are

When you buy a stock, you are buying a small piece of ownership in a company. If the company does well and grows in value, the price of your stock generally goes up. If the company struggles, the price goes down. Some companies also pay dividends, which are regular cash payments made to shareholders out of the company's profits.

Stocks have historically offered higher long-term returns than bonds or savings accounts, but they also come with more volatility. It is not unusual for the stock market to drop 20% or more in a given year, even though the long-term trend over decades has been upward. This is why stocks are generally discussed in the context of longer time horizons.

What Bonds Are

A bond is essentially a loan you make to a company or government. When you buy a bond, the issuer agrees to pay you a set interest rate for a specific period of time, then return your original investment (the principal) when the bond matures. Government bonds (like U.S. Treasuries) are generally considered to carry less risk of default than corporate bonds, though they typically offer lower interest rates in return.

Bonds tend to be less volatile than stocks, which is why they are often discussed as a way to balance out the ups and downs of a portfolio. However, they are not risk-free. Bond prices can fall when interest rates rise, and the purchasing power of fixed interest payments can be eroded by inflation over time.

What Funds Are

A fund is a way to own many stocks or bonds at once through a single purchase. Instead of buying shares of 500 individual companies, you can buy one share of a fund that holds all 500. The two most common types are mutual funds and exchange-traded funds (ETFs).

Mutual funds are priced once per day and are bought directly from the fund company. ETFs trade throughout the day on a stock exchange, just like individual stocks. Both come with an expense ratio -- a small annual fee expressed as a percentage of your investment that covers the cost of running the fund. These fees vary widely, from under 0.05% for some index-based funds to over 1% for actively managed ones.

Why This Matters

Understanding what stocks, bonds, and funds are is foundational. Nearly every 401(k), IRA, and brokerage account is built around combinations of these three things. When you hear people talk about their "portfolio," they are talking about their particular mix of stocks, bonds, and funds -- and every person's mix reflects their own situation, goals, and comfort with risk.