learn about investing part six stocks versus bonds today we're going to learn about the two basic building blocks of investing and we're going to kill two birds with one stone in this video as we'll use this introduction to stocks and bonds to further our discussion on risk and if you haven't figured it out by now risk is pretty much the most important aspect of investing to pay attention to and it will continue to pop up throughout the rest of this series now when it comes to investing we fund mentally have two options we can be owners or we can be lenders let's drive this concept home using an example let's say there is a small independent coffee shop in the neighborhood the owner has decided that he needs money so that he can open up a second store he comes to you and he gives you two options option number one if you give him $100,000 he will give you half of his company you would now own 50% of this company and in the world of investing ownership is known as equity and you might hear someone refer to the half of the business that you own as a 50% Equity stake since you and the original owner both own 50% of this company you each have one equal share now it's possible that you as an investor didn't have $100,000 to invest but the coffee shop owner could still have raised $100,000 by finding five investors who had each bought byy 10% of the company Bob might have divided his company up into 10 equal shares with each share being valued at $2,000 he would keep five shares for himself worth $100,000 and sell one share valued at $220,000 to each of the five investors he still raised $100,000 in total from outside investors if you wanted to he could have created 200,000 shares worth $1 each he would then have kept 100,000 shares for himself and sold the other1 100,000 shares to raise $100,000 he could have sold all 100,000 shares to one investor sold 20,000 shares to each of five different investors or sold one share to each of 100,000 individual investors so for now no matter how many shares he divided his business into the overall value of the business didn't change just the number of shares and the higher the number of shares the lower the value per sh share we'll see in a moment that of course share prices can change down the road and we'll get to that in a second for Simplicity sake let's assume that you are the only investor and that you put up $100,000 to own 50% of Bob's company now these Shares are more formally known as shares of stock and this term is often shortened down to Simply stock the following list of words all canote the same basic meaning ownership Equity shares shares of stock and stock these are all words that are essentially used interchangeably and they all refer to owning part of a company for example you might hear someone say I own 100 shares of apple or I own 100 shares of Apple stock or they might simply say I own Apple stock okay so the first option this coffee shop owner is offering to you to be an investor is as an owner we'll come back to this in a moment but let's look at option two now as I mentioned before there are two fundamental types of Investments we can be owners or we can be lenders option one was ownership option two is being a lender in this case the coffee shop owner wants you to lend him $100,000 he'll pay it back after 10 years and in the interim he will pay you interest on the $100,000 at the fixed rate of 4% per year 4% of $100,000 is $4,000 so you would lend him $100,000 and every year like clockwork he is proposing to give you a fixed payment until the end of year 10 at which point he gives you back your original principal of $100,000 so really this is just a loan most people are quite familiar with loans because we've all borrowed ourselves but we're familiar with it from the perspective of being the borrower The Entity we borrow from off in a bank is the lender and they are hoping to earn a return on their money because we pay interest while we've borrowed and then eventually pay it all back so when the coffee shop owner comes to us we are going to act like the bank in this case by providing the money he wants to borrow and we are hoping to make a return so option two is to loan the coffee shop owner money and since a loan is a debt you'll sometimes hear that word used when describing Investments that represent the lending of money and one of the most common phrases used to describe this basic type of investment is fixed income and that's simply because you're expecting a regular or fixed periodic payment and a payment to you is income in the world of investing these debt Agreements are known as bonds debt fixed income and bonds or a bond these are all words used to describe the second fundamental type of investment now that we have a rough framework for the difference between stocks versus bonds which we could also phrase as Equity versus fixed income or ownership versus debt we next have to figure out which option we would take as a quick aside if you're liking this video I would really appreciate it if you took a a tenth of a second to hit the like button as I continue on the ratio of likes to views helps promote the video on YouTube anyways back to the video so here is another great opportunity for a reminder of our favorite phrase the potential of higher returns necessarily comes at the expense of more risk so with that in mind let's perform a very simple analysis whereby we examine what would happen with a best case scenario and worst case scenario for each of our two inves options let's say our best case scenario is that our local coffee shop owner successfully opens his second store and after making a lot more money can now fund further expansion and ends up becoming the next Starbucks with the company now being worth $10 billion our worst case scenario is that the second store is a flop and both locations eventually go under and ultimately the coffee shop owner files for bankruptcy so we'll build a little Matrix here across the top we've got option one own and option two lend and remember this is the same as Equity versus debt or owning stocks versus owning bonds and remember bonds are fixed income and over here on the left we have our two possible outcomes the successful scenario and the unsuccessful scenario in option one we own 50% of the company so very simply if the value of the company increased to $10 billion our half would be worth $5 billion so that's possible albeit unlikely if the company goes bankrupt then it's worth nothing and half of nothing is also nothing so that's bad because we could lose all of our money that we invested in option number two where we agree to lend the coffee shop owner $100,000 in exchange for interest payments of 4% per year for 10 years we'll collect $4,000 every year for those 10 years for a total of $40,000 and then we'll get our $100,000 back for a total of $140,000 if this company ends up being the next Starbucks we'll likely be kicking ourselves in regret because we agreed to only ever get $40,000 in interest payments on our original $100,000 but in our unsuccessful scenario let's hypothetically say that the business didn't fail until the end of year 7 we would have collected 7 years of $4,000 annual interest payments for a total of $28,000 and if the owner was going bankrupt without going into too much detail for now we might get back0 50 cents on the dollar of our original $100,000 since he would own some coffee making equipment and cash registers and other things that he could sell off as he wound up the business that means that instead of giving back the $100,000 that we originally gave to him we might only get $50,000 back for example so $288,000 plus $50,000 means we end up with $78,000 while not good it certainly seems like a better option than losing all of our money so at this point we could say that by taking an equity stake owning stock we could possibly become rich or end up with absolutely nothing but by being lenders holding this Bond or fixed income type of investment we have very limited upside but the likelihood of losing money and how much we lose is much lower now it may not look just like that from our simple Matrix but let's add two more scenarios to drive this point home let's add in a moderately successful scenario and a moderately unsuccessful scenario where the owner barely Treads water the likelihood of either of these two scenarios are much higher than the two extreme scenarios we just looked at in our moderately successful scenario perhaps the second store is a success but there's no more expansion perhaps this business would be valued at $1 million after 10 years owning half of this business means that we would have a value of $500,000 if we opted for the bond we still get our same $40,000 in interest and our original principal back for a total of $140,000 and again that's what we agreed to in our moderately unsuccessful scenario the second coffee shop gets closed down but the original coffee shop remains open if we took the ownership option and let say that the business is now valued at $100,000 our 50% Equity stake is only worth $50,000 so we've lost half of our original investment but again if we opted to go with the bond option and our coffee shop owner can still make the interest payments and eventually pay back our $100,000 then we still got what we signed up for even in this less than ideal scenario for the business now remember this is an invest in 101 series what I want you to take away from this video is this in general stocks are riskier than bonds the upside potential is very high with stocks also known as equities but the trade-off is that you could also lose money and it's relatively easy for that to happen with bonds you have limited upside potential but you are more likely to get it and less likely to see big losses now I did take some small Li in this video for example a private business owner offering to pay 4% interest is generally not high enough in the real world because there's quite a bit of uncertainty versus investing in a bond from the government or investing in a bond from a Fortune 500 company accordingly the more risk there is the higher the rate of return or interest rate charged you should expect but again this is an investing 101 Series so we'll stop there since we covered a lot of ground today in the next video we're going to start discussing how these two basic building blocks we talked about stocks and bonds are used to build different investment products that you'll commonly see in the average Investment Portfolio we'll also explain what I mean when I say the word portfolio [Music]