Bonds
January 29, 2023 Beginner
Equity securities (stocks) and debt securities are common investment vehicles. Here's how securities work and how to use them in your portfolio.
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.
What are the different types of investment securities?
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.
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, for example, common stocks.
- Fixed income investments, including debt securities, such as bonds, notes, and money market instruments. Some fixed-income investments, such as certificates of deposit, may not be securities at all.
What are equity securities?
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.
What are debt 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 types of debt securities are corporate or government bonds and money market instruments, notes, and commercial paper.
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 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 securities are debt securities that provide returns in the form of periodic, or fixed, interest payments to the investor. Not all types of debt investments include a fixed payment. Some, in fact, have no payment at all but instead 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 as well as government Treasury bills and Treasury notes.
Securities recap
- Equity securities are financial assets that represent shares of a corporation.
- Debt securities are financial assets that define the terms of a loan between an issuer (borrower) and an investor (lender).
- Fixed income securities are debt securities that provide returns in the form of periodic, or fixed, interest payments to the investor.
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Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Investments in fixed income products are subject to liquidity (or market) risk, interest rate risk (bonds ordinarily decline in price when interest rates rise and rise in price when interest rates fall), financial (or credit) risk, inflation (or purchasing power) risk, and special tax liabilities. May be worth less than the original cost upon redemption. Schwab and all third parties mentioned are separate and unaffiliated companies and are not responsible for each other's policies or services.
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