Stocks and bonds: Everything you need to know — Updated for 2020

Investing is 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. Stocks and bonds are a great place to start, so we’re going to dig in on that in this post. But first, let’s talk about the typical perceptions of investing.

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

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…

…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.

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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.

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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 2%. (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.
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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:

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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:
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  • 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 $6,000 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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