This is probably the one you have heard the most about. This is due to it being the most common, widely available, high yielding investment out there. This is also the one investment that is most talked about by news media. When you are buying shares of stock you are buying shares of ownership in a company, sharing in their losses as well as their gains. Generally, the younger you are the larger the percentage of your portfolio should be made up of stocks. For example, say you are 20-years old. This would mean that your portfolio should contain approx. 20% bonds and 80% stocks. Now let's say you are 50 and plan to retire are 65. Your portfolio should now contain closer to 50% stocks and 50% bonds. The easiest way to keep your portfolio allocated properly in terms of stock/bond, risk/return characteristics is to follow this age based - percentage system. Your investment will increase in a stock investment from the appreciation in price of the companies stock.
This is an investment that you may have heard of but, probably don't know exactly how it works. Unlike stocks, when you are buying bond you are not buying ownership, you are buying the company debt or an "IOU". Bonds are less risky than stocks (less volatility) and this is why your portfolio contains more bonds as you get closer to retirement age. Bonds will pay a certain percentage on the money that you loaned. How a bond works: You find that XYZ company is selling AA+ bonds for a discount at $950.00 paying 5% interest for 10 years. To understand this you need to take a look at each part. First, the bonds grade (letters) a bonds grade works similar to how grades work in school. If XYZ company is selling AA+ bonds they are selling very safe, stable bonds, that are very likely to pay you back your $950.00 plus interest of 5% for 10 years. Now if XYZ company was selling C grade bonds it would likely carry a higher interest rates lets say 7% for the additional risk being taken on by the investor. This C grade bond also known as a junk bond or a high yield bond carries a higher risk of default (company will default on bond and investor loses investment) and are therefore forced to pay a higher interest rate. Most portfolio's will contain a balance of high-yield and investment grade bonds. Unlike a stock that increases in value due to price appreciation, a bond investment, increases in value from interest payments.
This is another one that you may have heard a little about, but, aren't too familiar with. There is a huge variety of different mutual funds. Mutual funds can be a cost effective way to have a well diversified portfolio (contain proper amount of bonds/stocks for single price). However, there are many different types of mutual funds, containing just about every type of investment that there is from all stock mutual funds to all bond and even all real estate. You typically find mutual funds in 401(k) funds and other types of retirement accounts. Mutual funds help to eliminate the risk of single stock risk at a cost that is much lower than purchasing hundreds of companies stocks on your own. Running a portfolio with a mutual fund is much safer than running a portfolio with one or even a couple companies stocks. When you are invested in only one or a few individual companies you are much more likely to lose money than if you were invested in hundreds of companies through a mutual fund. For example, say you own 3 companies and 2 out of the 3 fail. You've now lose 2/3 of your portfolio value. Now lets say you own a mutual fund that is invested in 100 companies. You can now afford for 50 different companies to fail (very unlikely to ever happen) before you would be even close to losing the value you lost from your "small" portfolio.
ETF (Exchange-traded Fund)
This is an investment that isn't as widely discussed. An ETF is similar to a mutual fund in that you are invested in a lot of companies. However, when you own shares of a mutual fund you also own small percentages of the companies within the fund. When you own an ETF you only own that particular fund, not the companies that the fund invests in. One large advantage of ETF's over mutual funds is that they can be actively traded. You can trade an ETF throughout trading hours 9:30a.m.-4:00p.m. where as a mutual fund, you will submit the trade request during trading hours but, the trade will not be executed until after hours. This causes for you to not know the exact price you are selling at, as you are selling at previous trading days price, not todays price, which would be the case when selling stock or an ETF. Purchasing an ETF is normally still much safer than purchasing shares of a single company because you get the liquidity (ability to sell/convert to cash quickly) like you would with individual stock but, you are also getting diversification similar to that of owning a mutual fund (in most cases - No 2 ETF's are the same).