Stocks, bonds, securities — to the uninitiated these terms may blend together, but legal and financial systems give them strict definitions.
Securities is a Broad Term for Various Types of Investments
Most sources define securities as financial instruments used to represent investments. This definition may present more questions than it answers for those without in-depth knowledge of the world of finance. Part of the reason for the confusion is the word “instrument,” which implies a physical object.
To understand the concept, you have to remember that stocks, bonds and the market itself came into existence before modern computing. At one time all financial investments were physically represented, usually with a certificate, which was the “financial instrument” in question. Today the instrument can be as simple as a few lines typed into a database.
Stocks are Profit-Based Investments
The stock market creates an easy way for businesses to find investors. Growing companies can file to become publicly held, at which point the business is divided into equal pieces, each representing a percentage of the business’s net worth. Investors then purchase these percentage-based stocks in the hope that the company will grow. Ideally, enough people invest to create an influx of cash, which the company uses to promote overall growth, so each piece, or “stock” becomes worth more to its owner.
Investing in stocks is a risky endeavor, but less so than it once was. When the market was new, securities fraud was far easier to commit. Dishonest brokers took advantage of investors in a number of ways, often creating fake securities for nonexistent entities or falsifying documents related to potential profit. Today’s laws require extensive proof of a publicly held company’s viability and strict adherence to disclosure requirements. Stock fraud still occurs, but investors are afforded some level of protection under the US Securities and Financial Fraud Laws.
Bond Investments are Debt-Based
Whereas stocks are securities based in growth and profit, bonds are debt-based. Companies or government entities take out loans, and the principal amount of the loan is broken up similarly to how businesses are divided in the stock market. The investment here, however, is in the debt’s interest. While stockholders are part owners of the companies in which they invest, bondholders are actually creditors.
Investing in bonds represents a lower risk. Financial fraud is less of a concern, because there is no benefit in falsely constructing or artificially inflating a debt. The stock market, however, due to the growth-based nature of most companies, potentially rewards higher dividends.
