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All about stocks and bonds — Updated for 2017

Ramit’s no-BS, plain-english take on how stocks work, buying bonds, and the best way to invest in stocks and bonds for a Rich Life.

Ramit Sethi

Anyone who knows me knows that I’m a BIG fan of investing.

It’s the single most crucial thing you can do to ensure your financial future — and the sooner you start, the easier it is to get rich.

This isn’t BS. There’s more than 100 years of evidence in the stock market that suggests this.

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And yet, people still don’t understand what investing is exactly. Folks seem to think there is some magical way to make a fortune with stocks and bonds. From what I’ve seen, the two things people get most wrong about investing are thinking:

  1. It’s a 24-hour Wolf-of-Wall-Street—style party where traders make millions of dollars daily while screaming “SELL! SELL!!” into a phone.
  2. Investments are incredibly risky because all the pundits scream “financial crisis!” at even the slightest dips in the markets.

And, frankly, you have every reason to believe this.

Thanks to Hollywood and the (annoying) talking heads on cable news, we’ve come to think of investment as a maniacal creature that’s not suited for the average person…

…not to mention the fact that we’re STILL seeing the effects of the biggest stock market crash in generations…

…and many of us just don’t understand exactly how investing works.

That’s why I want to dispel some of those myths and notions surrounding investing today by focusing on some of the most common topics you’ll hear when it comes to investments:

  1. How do stocks work?
  2. What is a bond?
  3. A bullshit-free look at investing for your future

This article isn’t going to be about which stocks are hot right now or what sort of investment strategy is going to make you into a zillionaire today. If you’re looking for something like that, I suggest you go back to watching the pundits on cable news. SPOILER ALERT: Cramer has done much worse than the S&P 500 since 2008.

Instead, I’m going to give you a no-BS lesson on what stocks and bonds are and what function they can serve in your investment future.

How do stocks work?

When you own a company’s stock, you own part of that company. Stocks are also called equity for that reason — you own a tiny piece of the company.

Stock basics
Choosing the right stock
Stock research resources

Stock basics

If the company does well, your stock will do well. You can buy and sell whenever you want through your broker or self-serve sites like E*Trade or TD Ameritrade.

Inevitably, whenever I’m teaching someone about the basics of stocks, someone will pipe up with a myriad questions like these:

  • “What stocks should I buy?”
  • “Is X company a good investment?”
  • “Is $XX too much for this stock?”

First thing’s first: SLOW DOWN.

Before you make an investment in any sort of stock, you’re going to want to stop and make sure you understand how to go about making a decision of what stock to buy.

Choosing the right stock

The simplest way to narrow down the universe of stock options is to think of companies you like and use.

Take some time right now to write down 15 companies you use and return to time after time.

Think of everything. For example:

  • Food: Whole Foods, Conagra, Shake Shack
  • Clothing: Under Armour, Limited Brands, Etsy
  • Services: IBM, UPS
  • Technology: Apple, Microsoft, Snap
  • Entertainment: Disney, Live Nation, Netflix
  • Transportation: Tesla, Ford, CSX Corporation

Instead of 5,000 stock options to choose from, you now have 15 companies you could possibly invest in.

Remember: A good company isn’t necessarily a good stock!

For any stock, you’re going to need a deeper analysis than “I think khakis from Gap are awesome, so I’ll buy stock from them!”

Instead, you’re going to want to look at 5 different areas:

  • Trends: Are sales increasing from this time last year? 2 years ago? 5 years ago?
  • Products: Is the future bright in terms of upcoming product development? What news have you heard about their future products?
  • Revenues/profits/growth/earnings per share: The real financial nuts and bolts of a stock. These are intimidating at first. Luckily, many sites will guide you through it.
  • Insider trading: Are senior executives at the company buying more stocks (indicating they have confidence in the company) or selling?
  • Management: Is management good? What is the turnover? What is their philosophy and ability to execute?

You can get all of this information online for free — and you’d be wise to do as much research as you possibly can. If you see a reason to doubt a company based on any of the areas above, avoid that stock.

Stock research resources

Here are some great websites to help you start out:

At first all of the charts, earnings, and balance sheets will be incredibly confusing — but the more you look into them the more you’ll start to get a good sense of what’s going on. It just takes practice

Advantages: You can really make some money if your stock is good. If your stock is excellent, you can really beat the market. You can pick the stock in an industry you understand. Also, your money is liquid, which means you can access it at any time by selling your stock.

Disadvantages: Unfortunately, if a company does poorly, so does your stock. Because a stock isn’t diversified, that can mean disaster for you (although you can easily reduce your risk by picking bigger, solid companies).

Also, most people think that investing is “picking stocks” but most wealthy people don’t do that — and I’ll show you what they DO do later in this post (more about investor psychology).

What are bonds?

Bonds are like IOUs that you get from banks. You are lending them money in exchange for a fixed amount of interest.

Bond basics
Advantages of bonds
Disadvantages of bonds

Bond basics

If you buy a 1-year bond, the bank says, “Hey, if you lend me $100, we’ll give you $102 back in a year.”

The approximate current rate of return for a 2-year bond is about 1.5%. (Check here for the up-to-the-second number.)

Overall, bonds are:

  • Extremely stable
  • Guaranteed to have a return
  • Smaller in their returns

With these qualities, what kind of person would invest in bonds?

Well, anyone who wants to know exactly how much they’re getting next month should invest in bonds. It doesn’t matter if you’re in your twenties or if you’re in your seventies. If you want a stable investment — despite the lower returns — then bonds are for you.

After all, some people just don’t want the kind of volatility the stock market offers. And that’s fine.

Advantages of bonds

  • You know exactly how much you’ll get when you invest in a bond.
  • You can choose the amount you want a bond for (1 year, 2 years, 5 years, etc).
  • Longer time periods can yield you higher return rates.
  • Bonds are extremely stable, especially government bonds. The only way you’d lose money on a government bond is if the government defaulted on its loans — and it doesn’t do that. It just prints more money.

Disadvantages of bonds

  • Because they’re so stable, the reward on an excellent bond is dramatically less than an excellent stock.
  • Investing in a bond also renders your money illiquid, meaning it’s locked away and inaccessible for a period of time unless you’re willing to incur a big penalty to take it out early.
  • Unlike stocks, bonds are hard to buy and sell as an individual.

Your investment future without bullshit

When it comes to what you want to invest in, I think both stocks and bonds are solid investments — as long as you do your research.

When it comes to what I think EVERYBODY should be doing when it comes to their investments, it’s simple: low-cost, diversified index funds.

Let’s look at a real world example.

Say you’re 25 years old and you decide to invest $500/month in a low-cost, diversified index fund. If you do that until you’re 60, how much money do you think you’d have?

Take a look:

pasted image 013

$1,116,612.89.

That’s right. You’d be a millionaire after only investing a few thousand dollars per year.

Smart investments are about consistency more than chasing hot stocks or anything else:

The two essential ways to invest your money are straightforward:

  • 401k: Take advantage of your employer’s 401k plan by putting at least enough money to collect the employer match into it. This basically means that for every dollar you contribute, your company will match that (pre-tax!).

    This ensures you’re taking full advantage of what is essentially free money from your employer. That match is POWERFUL and can double your money over the course of your working life:

image00 4

  • Roth IRA: Like your 401k, you’re going to want to max it out as much as possible. The amount you are allowed to contribute goes up occasionally. Currently you can contribute up to $5,500 each year.

Note: If $500/month sounds like a lot, read all the ways you can free up that money with just a few phone calls.

If you are just starting out, it’s so awesome that you’re here.

For financial security, it’s more important than anything else to start early. And don’t worry if you think you’re a little late to the game. After all, the best time to plant a tree was 20 years ago…the second best time is NOW.

Man, I’m starting to sound like a fortune cookie.

Anyway, my team has worked hard on something I think will help ease you into the world of investing: The Ultimate Guide to Personal Finance.

In it, you’ll learn how to:

  • Master your 401k: Take advantage of free money offered to you by your company…and get rich while doing it.
  • Manage Roth IRAs: Start saving for retirement in a worthwhile long-term investment account.
  • Automate your expenses: Take advantage of the wonderful magic of automation and make investing pain-free.

Bonus: Want more advice on how to improve your finances? Sign up today and get your free copy of The Ultimate Guide to Personal Finance.

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31 Comments

 
  1. imelda

    Quick question about bonds– my mother is in her late 50s and has almost nothing saved for retirement. Believe me, I know how depressing that sounds.

    Is it worth her while to buy some bonds, or is it pretty much not going to do any good this late in the game? Please note that we’re not exactly talking about thousands of dollars here.

    Thanks!

    • jay

      As stated above in the article 2.89% rate per. year so that’s $2.89 for every $100 tied into the bond and the bare minimum for it is $1,000 with a min. 2yr holding on the bond higher $$$ with more time invested in the bond receives more up to 7% i believe that’s like 10,000 or more with 10 yrs holding either way bare minimum that’s $28.90 a year for 2 years you didn’t even make 60 bucks for the 2 years it was untouchable to you as an asset that whole time as well unless you withdraw it early and loose the %age you would have “Made”!I would do as he said and anylise what you use on a daily basis and once you have selected your Brands anilyse their stocks sucess and slowly invest once you have some footing look at more products that maybe you dont personally use but are popular

  2. Ash

    Bonds usually have 5-7% return, more return the riskier the bond is. I’d suggest you get a CD or the best is to put the money in the online savings account. HSBC gives 5.05% on savings and your mom can use any HSBC ATM to withdraw money anytime.

  3. Robby

    You didn’t mention that the rich invest in government bonds because the returns are tax free. That is a significant advantage when you are in the highest tax bracket.

  4. Vince

    Another great on-line savings account is emigrantdirect.com. It’s paying 5.15%.

  5. Harm

    Government bonds are NOT for the most part tax free, not from the Feds they’re not (from state tax they are, mostly)….Municipal bonds are free from federal income tax….

  6. Wayne

    I’m a middleaged man who is full of admiration for the quality of the advise on your site.

    Who said that ‘you can’t put an old haed on young shoulders. It has taken me many years to learn what you already know. I also share your views on Real Estate. If people really need ‘bricks and morter’ they could consider researching large property trusts, Like (Westfield or Lead Lease on the ASX)
    Congratulations on a wonderful site.

  7. Ernie

    Which one would be the most appropriate, for a younger like myself at the age of 20, either stocks, bonds or CDs.

  8. Laura Dencer

    I know why stocks fluctuate in prices, but who has the authority to set the price?

  9. Nikita P.

    Hello there,

    I’m playing a free version of the Stock Market Game on my school computers. We’re not doing so well because we failed to find descent stocks. Are there any stocks that you personally love or enjoy using every now and then? If so, please share the ticker symbol with us.

    Thank you in Advance

    ~Nikita, Andrew, Billy

  10. colt edillor iii

    How long do you think I would sell my stock if ever I bought some…By the way, I am studying this very interesting field of earning money…I m in my mid-30s Id like to invest..though, I dont have that big money…Do u think is it possible even I dont have the big bucks to invest in Stocks?

  11. sukaina jaafar

    Hi. I am a college student and i am doing a project that consists of investing 1,000,000 dollars for a company over 5 years. What do you think i should lean towards, stocks or bonds?

  12. lisa

    How much money do u need to get started?

  13. drain

    Your advice/statements/comments show your lack of experience.

  14. hh

    I’ll have to disagree about your reasoning on bonds for those in their 20’s. Assuming that most will be saving to buy a house in their 30’s, you would want a stable source of income (so you can withdraw it anytime) for the downpayment on the house, which will probably consume the savings of most (except your friends who make six-figures).

  15. Jana

    Hi- My husband and I are looking to invest some money into stocks and we are extremely new to this, so I was wondering what the minimum stock purchase would be.

    • John smith

      A minimum of £100 would be a start.

  16. Paolo

    What ever happened to using bonds as a smart way for diversification??? I believe it was John Bogle who said that you should invest x percent of your assets in bonds, where x is your current age. Are you contradicting Mr Bogle?

  17. jessica

    thank you for this site it gives a lot of insight into the world of stocks. i am in the tenth grade and doing research and i just wanted to let you know how much it helped and how much i appreciated it. thank you again

  18. nnamani kingsley

    please i want to know the criterion to be considered before buying stock, in a company

  19. Sandy

    I am in my early 30’s and want to invest for a retirement. However, I am not exactly sure where to begin or what to invest in. I don’t have a lot of money at all and basically live paycheck to paycheck. I am raising 2 kids, so I want to start out with something kind of small and then gradually put more and more in. Do you have any suggestions? I would greatly appreciate any help.

  20. Deena

    I know nothing about stocks or bonds. Just thought of them at 44! I have 40K waiting to multiply. Any suggestions?

  21. carlos

    I 43 yeas old. pay off my house not bills. got 2 young kids. thinking in invest some extra cash for kids collegues and retirement, where i should invest for term of 15 years with a good return…

  22. Jimmi Belle

    Thank you for the blog…. I take stock services from Multi Management and Future Solutions and I really had a good experience their services are good . Before starting stock trading I First took the three days free trial because I don’t want to be in risk and that really helped me.

  23. NEYTHAN

    Am a young entrepreneur,currently doing produce business (maize,rice,wheat,beans etc) and am in Africa Uganda in particular,so how can I invest in bonds using this idea which seem to favour USA citizens.regards Neythan

  24. Neha Varma

    It is very informative article about stocks and bonds. I liked your post very much. All the benefits are great for us. I am pleased to get Tradebulls excellent information. Keep share helpful information with us. Thanks you so much.

  25. Patrick

    Hello, I have been researching and dabbling in stocks for a few years now. I have tried several ways and learned a lot. I was in my early 40s before deciding to look into this new venture towards making money. It took a few years but I have found my first niche in penny stocks. I actually got lucky and found a guy who specializes in low end penny stocks. I was checking posters out on Investorshub when I found the page “triple zero and sub-penny chart plays. You can always tell when he is excited about a stock because he posts on it multiple times over and over. I started with only a couple hundred dollars and have made a couple thousand. This is over a period of less then a year. I am hoping that I can make enough to eventually start shorting penny stocks, where the real money is at. You will never make this much money with big stocks where you have a better chance of losing money then making any. Leave that to the rich people. Only they can make anything from big ones. I generally buy a stock at .0001 and wait for it to climb. I always set an order to sell where I think it will stop and take the cash and pay bills I need to or for a trip. Mostly I want to reroll it in stocks. Using this page and my strategy I am on my way to financial freedom, I hope. Also remember penny stocks are pretty much all scams so NEVER hold them. Take your quick cash and run. This is why I said shorting is where the big money is at, you can count on them to drop in price quickly after a run. If you have $25,000 or more you can short on most broker sites, there is one that does it for less but is not as reliable. Do your research before committing to any program. I also recommend practicing trading on paper or a site that allows it. Make sure you have a clue as to what you are doing and will make money instead of just throwing it away. Good Luck.

  26. Carmen

    Thank you for this post, Ramit.

    I've always wanted to get started in stocks n' bonds but had no freaking clue how and the majority of the information out there is either for advanced learning or downright wrong.

    Thank you.

  27. weston17

    I disagree. Read that
    http://www.forbes.com/sites/davidsturt/2015/11/06/007-powerful-habits-to-learn-from-james-bond/

  28. Mighty Investor

    Another key thing to consider when thinking about investing in stocks or bonds is that when you spend a ton of time researching and investing in individual stocks or bonds you are losing time you could have spent developing your career or a side business.

    Is the time you spend researching stocks best spent that way? That will only be so if you can consistently outperform index funds. A tall order. If you are just matching (or doing worse than) the indexes, you would be much better off spending less time on research and getting out there and focusing on your career and developing skills to enhance your earning potential.

    Yes, investing is super important, but learning to successfully evaluate, buy, and then sell at the right time individual securities is an insanely rare skill.

  29. evadob

    I disagree, look at that
    https://www.newamericanfunding.com/blog/market-update-looking-ahead-and-cheap-versus-rich/