Investing Part Six: Stocks vs Bonds

Overview

• Focus on two basic building blocks of investing: stocks (equity) and bonds (fixed income).
• Importance of understanding risk in investing.

Two Fundamental Investment Options

1. Ownership (Equity)

   • Example: Coffee shop owner offers an investment opportunity.
   • Investor can own 50% of the business for $100,000.
   • Terms:
     • Shares can be divided into different amounts.
     • Owning part of the company is referred to as equity.
     • Interchangeable terms: shares, shares of stock, stock.

2. Lending (Debt)

   • Coffee shop owner offers a loan option.
   • Investor lends $100,000 for 10 years at a 4% interest rate.
   • Terms:
     • Fixed income means receiving regular interest payments until the loan is paid back.
     • Common terms: bonds, fixed income.

Risk Analysis

• Higher Returns vs Higher Risk
  • The potential for higher returns generally comes with increased risk.
• Scenario Analysis:
  • Best Case:
    • Coffee shop becomes a successful franchise (e.g. Starbucks) worth $10 billion.
    • Investor with equity would have stake worth $5 billion.
  • Worst Case:
    • Business goes bankrupt; equity investment becomes worthless.
    • Debt investment returns only partial amount.
• Matrix for Analysis:
  • Ownership (Equity) vs Lending (Debt):
    • Best case for ownership: $5 billion.
    • Worst case for ownership: $0.
    • Best case for lending: $140,000 (interest + principal).
    • Worst case for lending: $78,000 (interest + partial repayment).

Moderate Scenarios

• Moderately Successful:
  • Business valued at $1 million after 10 years.
  • Equity stake worth $500,000; bond investment returns $140,000.
• Moderately Unsuccessful:
  • Business valuation drops to $100,000.
  • Equity stake worth $50,000; bond investment still returns $100,000.

Key Takeaways

• Stocks (equities) generally riskier with high upside potential.
• Bonds (debt, fixed income) have limited upside but are more stable and less risky.
• Practical examples of risk and return should be understood for informed investing decisions.
• Next video will cover how these building blocks are used in creating investment portfolios.