Bonds and Mutual Funds Explained

When it comes to investments, perhaps the best-known type is stocks. We hear about how popular stocks are doing every day on the news, and when the economy takes a turn for the worse, we hear about how the stock market in general has plummeted. But stocks are far from the only type of investment out there.

There are some types of investment that are completely unrelated to stocks. Many others are based on stocks, either in part or in full. Here are the basics on two popular types of investments: bonds and mutual funds.

Bonds

Bonds are often mentioned in conjunction with stocks, but they are two entirely different things. Stock shares are ownership interests in companies that choose to sell them. Bonds, on the other hand, are debt securities.

Stocks and bonds do have something in common in that they are both used by corporations to obtain capital. But bonds may also be issued by local, state and federal governments. And while the money received from the sale of stock is not repaid, money received from the issue of bonds is. A bond is similar to a loan, because the principal plus interest is paid back after a specified period of time.

A unique aspect of government bonds is that the interest received may be tax exempt. Federal government bonds are not subject to federal income tax. State and municipal bonds usually aren't taxable if you live in the state where they are issued.

Mutual Funds

Most investors agree that in order to invest successfully, you must diversify. This means investing in a variety of investment types. One of the easiest ways to do this is to buy into a mutual fund.

Mutual funds are pools of money that are invested in several different assets. They may include investments in stocks, bonds or cash, or a combination of the three. These funds are managed by professionals who know how to get the best possible returns.

Some mutual funds allow investors to buy shares with one lump sum investment. But most allow investors to put money in on a regular basis. Mutual funds may be purchased through banks, brokerage firms, or directly from financial companies. Those purchased through a bank or brokerage often require the payment of fees or commissions, while most mutual funds purchased directly from financial companies do not.

When purchasing a bond or a mutual fund, it's important to take a look at its past performance. Bonds are rated according to the issuer's credit history and current status. Mutual funds must publish a prospectus each year that details their performance. These tools make it easier for investors to make an informed choice.

Like all investments, bonds and mutual funds carry some risk. A financial advisor can help you choose the right ones for your purposes.