Shares, bonds and funds: three different mechanisms

Beginners are usually given all three in one breath, as though they were three versions of the same thing. They are not versions: they differ in legal nature, in where the income comes from, and in how they behave in a crisis.

A share is a stake in a business

Buying a share makes you a part-owner of a company. Nobody owes you anything: the income may be nil or it may be substantial. The return comes from a rising price and from dividends, and both are decisions — of the market and of the board — rather than obligations.

There is no upper limit on the return. There is a lower one: the security can become worthless.

A bond is a loan at a known rate

Buying a bond means lending to an issuer — a government or a company. It undertakes to pay a coupon and return the face value at maturity. That is an obligation, not an intention, and it is exactly why a bond's return is capped: nobody pays more than promised even in an excellent year.

The risk here is different: the issuer may fail to pay. And there is a second, less obvious one — a bond's price moves with interest rates in the economy.

{{figure:bond-price-vs-rate|caption=The coupon is fixed at issue, so the only way a bond can adjust to a new rate is through its price}}

More in Bonds from scratch: what the income is made of.

A fund is a basket bought in one trade

An exchange-traded fund owns a set of securities, and you own a share of the fund. One trade gives you dozens of positions at once, and the fund charges a management fee for it. The mechanics are covered in BPIF, ETF and mutual fund: three forms of one idea.

What they have in common

All three trade on an exchange, all three are recorded at a depository, and all three can fall in price. The difference lies in what sets the price and in what happens in the bad scenario.