Let’s start with the basics. What’s the difference between a stock and a bond? I will explain this concept by starting a hypothetical company, Kristi’s Ranger Cookie Food Truck.
Ask any member of my family, neighbors, cat sitter, or school bus drivers, I make the best Ranger Cookies on the planet. Stay tuned for bonus blog for the recipe. But, I digress.
To raise capital for my food truck business, I can bring in additional owners (and their money) or I can borrow money.
To raise money, I can sell stock in my company. The amount of stock I sell to each investor denotes the amount of ownership they now have in my food truck company. The more stock I sell, the more money I get, but the more control I give up.
My stockholders have a vote in how I run my company. They also will share in any profits I make to an unlimited degree. If my food truck goes out of business, my stockholders’ investment will become worthless. I don’t owe them any money back in the case of the business folding.
However, I may not want a bunch of nosy stockholders telling me how to bake my cookies. So, I might choose to raise money by borrowing it instead. This is called selling bonds. Bonds are typically sold in units of $1,000 each. So, if I want to raise $10,000, I need sell 10 bonds.
Bonds are a loan arrangement with a pre-determined interest rate paid to the bond owner and a pre-determined date that the loan amount will be returned. If the food truck does amazingly well and expands like Chipotle, I only owe my bondholders the interest I promised them – none of the additional profit. If my food truck goes out of business, I owe the bondholders as much as I can pay them of their original loan to me.
As you can see, a stock owner has more potential for making money, but also more potential for losing it. A bond holder’s upside potential is limited, but if the company goes out of business, there is a chance that he will get some of his investment back. Many companies sell both stocks and bonds to raise money to grow their businesses.
Next week, we’ll talk about how you can invest in the stock and bond market using mutual funds.