Stocks and bonds are both securities. Learn about these investment securities and understand the difference between equity securities and debt securities.
If you’ve done any investing at all, you’re probably familiar with the more common terms describing traditional securities: stocks, bonds, exchange-traded funds (ETFs), mutual funds, and so on. But sometimes other specialized terms can leave the average investor confused or uncertain.
For example, most investors know that stocks are also referred to as equities. And an equity is a type of security. But not every investor may know the difference between a fixed income security and an equity.
When it comes to bonds, most investors are probably familiar with the terms debt securities and fixed income securities. But perhaps you aren’t entirely familiar with the specific characteristics that define them.
Let’s define a few common security types using U.S. definitions.
Securities are commonly thought of as tradable financial assets. Although that’s an oversimplification, illiquid securities that don’t trade are not of interest to or suitable for the majority of investors. Most securities are issued by institutions (typically corporations and governments) for the purpose of raising capital, and those that are most available to investors are traded in public markets, such as the New York Stock Exchange or with a broker.
Because investment securities cover a wide range of assets, they’re divided into broad categories, two of which will be our main focus:
Equity securities are financial assets that represent ownership of a corporation. The most prevalent type of equity security is common stock. And the characteristic that most defines an equity security—differentiating it from most other types of securities—is ownership.
If you own an equity security, your shares represent part ownership of the issuing company. In other words, you have a claim on a percentage of the issuing company’s earnings and assets. If you own 1% of the total shares issued by a company, your ownership piece of the controlling company is equivalent to 1%.
Other assets, such as mutual funds or ETFs, may be considered equity securities as long as their holdings are composed of pooled equity securities.
Fixed income investments are debt instruments, where a lender (investor) will lend money to a borrower or issuer (often a government or corporation) in return for regular interest payments (coupon) throughout the specified term. The principal is returned to the investor at maturity. The most common types of fixed income securities are government and corporate bonds.
When you purchase a bond from an issuer, you’re essentially lending the issuer money. In most cases, you may be lending money to receive interest payments on the money loaned. And upon maturity, you hope to receive the full notional amount of your money back.
Caveat: Fixed income securities also carry risk—including price risk and credit risk, depending on the type of instrument and the issuer. Change in interest rates can create price risk. Credit risk is the chance the borrower may not pay back the debt when due.
Not all types of fixed income investments include a fixed periodic payment throughout the life of the term. Some, in fact, have no payment at all, but instead, incorporate the interest effect into the sale price up front, such as U.S. government-issued Treasury bills. Other examples include certain variable income securities, such as floating rate notes and variable rate demand obligations.