Stocks and bonds are both securities. Learn about these investment securities and understand the difference between equity securities and debt securities.
Whether most of your portfolio is in equity investments or fixed income investments, most of us are familiar with the more common terms describing traditional investment securities: stocks, bonds, exchange-traded funds (ETFs), mutual funds, and so on. But sometimes specialized terms can leave the average investor confused or uncertain.
For example, most investors probably 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 and differentiate the two.
To add more confusion to the mix, the word security may also vary in legal definition from one country to the next.
So, in case you’re still wondering about the definition of securities in general versus stocks and bonds, let’s define a few of the more common security types (according to 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 vast majority of investors. Most securities are issued by institutions (typically corporations and governments) for the purpose of raising capital. Hence, almost all securities are seen as forms of investment.
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 shares of ownership. The most prevalent type of equity security is the 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 expect to gain from what could hopefully be an increase of the issuing company’s earnings and assets. If you own 1% of the total shares, or security stocks, issued by a company, your part ownership 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.
Debt securities are financial assets that define the terms of a loan between an issuer (the borrower) and an investor (the lender). The terms of a debt security typically include the principal amount to be returned upon maturity of the loan, interest rate payments, and the maturity date or renewal date.
The most common type of debt securities are bonds—e.g., corporate bonds and government bonds—but also include other assets such as money market instruments like commercial paper and notes.
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. (Some debt securities, such as exchange-traded notes, are used as a proxy for other tradable instruments and do not offer dividends or interest payments.) And upon maturity, you hope to receive the full notional amount of your money back.
Caveat: Debt securities also carry risk—including price risk and credit risk, depending on the type of instrument and the issuer. Changes in interest rates can create price risk. Credit risk means the chance the borrower may not pay off the debt when due.
Fixed income investments include debt securities that provide periodic and “fixed” interest payments to the investor. The most common type of fixed income investments are also securities—like corporate bonds and government bonds.
Not all debt investments have a literally fixed payment. Some, in fact, have no payment at all, but rather they incorporate the interest effect into the sale price up front. Other examples include certain variable-income securities such as floating rate notes and variable rate demand obligations.
Other forms of debt obligation securities include government Treasury bills (T-bills) and Treasury notes (T-notes).
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