The Investment Series: Stocks and Bonds

You’ve probably heard of the name Warren Buffett, possibly Ray Dalio and perhaps less likely, Jack Bogle. Each of these men can attribute, partly or wholly, their successes and financial affluence to their investments in the markets.

With a current net worth of $85.6 billion, Warren Buffet is one of the most well-known investors in the world. How, you ask, does one leverage the market well enough to become the 4th richest person in the world? Honestly, friends, if I knew the secret to that question, I’d probably be in DXB right now, sipping a Pornstar Martini on the 43rd floor of the Burj Khalifa. But until then, my best advice is to know the basics!

Before we get into the good stuff, I must stress that this article is not investing advice – I am not an expert. If you are interested in investing in the markets but not sure when, where or how to start, please seek professional advice. All investments fall as well as rise in value, so you could get back less than you invest.

What are stocks?

Stocks, shares or equities are the most commonly used financial instrument in the world today. They are used daily by international conglomerates, investment banks and everyday investors like you and I. The stock market today stands at a value of $85 trillion.

Stocks are a unit of value that represent a fraction of ownership of a public company. Companies issue stocks (sell ownership) to raise money to fund projects or raise capital. Thus, anyone that buys a stock becomes an owner of that business, a shareholder. Stocks are not tangible, like a phone or bottle of water – it’s not a thing you can touch. It’s a non-physical unit of value, almost like money before you withdraw it from an ATM.

The mechanics of stocks can be fairly complex, so for those that are interested in knowing more, feel free to read on at your leisure.

How do you make money from stocks?

So, you’ve bought your stock and now want to know how to cash in your gains – as you should! There are two main ways of doing this: growth and dividends.

Starting with growth. Say you bought a share in Amazon for $120 last week, this would be your initial investment. Today, that same stock is now worth $130, which means, if you were to sell at current prices, you would have made a profit of $10. Similarly, if the market value was to fall to $115, you would have lost $5. Note that this is just one stock. Let’s say you bought 10 stocks at $120, in total worth $1200, the aforementioned gain would be $100 – very nice!

Then there are dividends. Dividends are a more elusive and complicated feature of market wealth generation, however they are quite rewarding if used correctly. Not all companies pay dividends, but those that do pay them to shareholders periodically (e.g. monthly or quarterly). For the purposes of this definition/illustration, I will be referring to cash dividends.

Say you bought a share in International Business Machines (IBM) for $100 with a dividend yield of 5%. The dividend yield is financial ratio, expressed as a percentage, showing the amount of money a company pays shareholders for owning a share of its stock divided by its current stock price.

Dividend Yield = annual dividends per share / price per share

So, using our above example, the 5% yield means owning one share will give you an annual income of $5. Now, if you had bought 100 shares initially, worth $10,000, the 5% dividend yield would give you an annual income of $500 – happy days!

Again, dividends can be fairly complex and there is another form of dividend called a ‘stock dividend’. So, for anyone interested in understanding more, please do some further research.

Bonds: the financial market’s IOU

Bonds are a fixed income instrument of corporate or governmental debt. It represents a loan paid by an investor to a borrower – an ‘I owe you’. The mechanism of bonds are, even at a high level, pretty confusing, but I will try to keep it as straightforward as possible. There are two main categories of bonds: corporate and government. There are also municipal bonds and agency bonds (don’t ask me what these are – I have no idea).

For the simplicity of this example, let’s say you are going to buy the Barclays two-year corporate bond for £1000. We can also make a further assumption that you are not going to sell this bond before the end of the two years. Your initial £1000 investment will be the principal or face value. At the end of the two years, you will get this back in full. This is called the maturity.

Between now and the maturity, Barclays may choose to pay you for your investment in the form of a periodic coupon of 10% paid annually. What this means is Barclays will pay you £100 for every year you own their bond. So, by year two, Barclays would have paid you £200 PLUS the £1000 principal you invested at the start. Nice bit of pocket change, there!

What makes this fixed income product so complex is the fact that its value is impacted by external market events, such as inflation or interest rates. Bonds can also be bought and sold on the markets, hence why I stated the above assumption that we kept our bond until maturity. I’ll leave it to you, Google and your Financial Advisor to figure out what these might mean for your investments.

That’s all for now, folks!

Alas, our short time has come to an end. But I hope this has helped to give you some basic understanding into what might become the start of some profitable future investments. In the next article, I’ll be looking to cover what the financial ‘markets’ actually are. I’d also like to touch on what the bear and bull market terms mean, and finally end with equity fund investing (index, mutual and ETFs).

This article was originally published on The Real Talk blog by Ayo.

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