Stocks, Bonds, and ETFs Explained

The Three Building Blocks

Every investment portfolio, from a beginner’s first $100 to a billion-dollar fund, is built from the same three ingredients: stocks, bonds, and funds that combine them. Understanding these three is the foundation of everything that follows.

Think of it like cooking. Before you can make any meal, you need to understand what protein, carbohydrates, and fats do. Before you can invest wisely, you need to understand what stocks, bonds, and ETFs do.

Stocks: Owning a Piece of a Company

When you buy a stock, you buy ownership. You own a tiny fraction of that company.

The analogy: Imagine your friend opens a pizza restaurant. They need $100,000 to start. They offer you 10% ownership for $10,000. If the restaurant succeeds, your 10% becomes worth much more. If it fails, you lose your $10,000.

That’s a stock—except instead of a friend’s restaurant, it’s Apple or Toyota or a thousand other companies. And instead of 10%, you might own 0.0001%.

How Stocks Make Money:

1. Price appreciation You buy at $50, the company grows, the stock rises to $80. You sell for $30 profit.

2. Dividends Some companies share profits with owners quarterly. Think of it as rent from your ownership.

Stock Risks:

• Prices can drop—sometimes a lot, sometimes quickly
• Individual companies can fail entirely
• Short-term prices are volatile and unpredictable

Use AI to understand any stock:

Explain [company name] stock to me like I'm a complete beginner.
What does this company do? How does it make money?
What's the bull case (reasons it might go up)?
What's the bear case (reasons it might go down)?
What would I need to watch to decide if this is a good investment?

Bonds: Lending Your Money

When you buy a bond, you’re making a loan. The borrower (a company or government) promises to pay you back with interest.

The analogy: Your neighbor asks to borrow $1,000 for a year. They’ll pay you $50 interest (5% annual return) and return your $1,000 at the end. That’s essentially a bond.

How Bonds Make Money:

1. Interest payments (coupons) Regular payments—typically every six months—at a fixed rate.

2. Return of principal When the bond “matures” (the loan period ends), you get your original investment back.

Bond Risks:

• Interest rates rise, making your bond’s fixed payments less attractive (price drops)
• The borrower could default (not pay you back)
• Inflation can erode the real value of fixed payments

Types of Bonds:

Key insight: Bonds are generally safer than stocks but return less over long periods. They’re the seatbelt in your portfolio—boring until you need them.

ETFs: The Best of Both Worlds

An ETF (Exchange-Traded Fund) is a basket of investments you can buy with a single purchase.

The analogy: Instead of buying one pizza restaurant, imagine buying a tiny share of every pizza restaurant in the country. If three restaurants fail but the pizza industry grows overall, you still come out ahead.

How ETFs Work:

An S&P 500 ETF, for example, holds all 500 companies in the S&P 500 index. When you buy one share, you effectively own a sliver of all 500 companies.

Why Beginners Love ETFs:

• Instant diversification: One purchase, hundreds of companies
• Low cost: Expense ratios often under 0.1% per year
• Simplicity: No need to research individual companies
• Flexibility: Buy and sell like stocks during market hours

Common ETF Types:

Quick Check

Your friend says: “I put all my savings into one stock because I really believe in the company.” What’s the risk they’re not seeing?

How These Three Work Together

Here’s why you don’t choose one—you combine them:

Stocks:  Higher potential return + Higher risk
Bonds:   Lower potential return + Lower risk
ETFs:    Easy way to hold many stocks and/or bonds at once

A typical beginner portfolio might look like:

• 70% Stock ETFs — Growth over the long term
• 30% Bond ETFs — Stability and income

As you get closer to needing the money (retirement, a house), you gradually shift more toward bonds. We’ll cover this in detail in Lesson 4.

Using AI to Compare Investments

AI makes comparison analysis accessible:

Compare these two investments for a beginner with a 20-year time horizon:

Option A: S&P 500 index ETF (like VOO or SPY)
Option B: Individual shares of [company]

Compare on:
1. Diversification
2. Historical average annual return
3. Worst-case scenario (biggest single-year loss)
4. Fees and costs
5. Effort required to manage
6. Which is more appropriate for a beginner and why

Key Concepts Summary

Key Takeaways

• Stocks are ownership (higher risk, higher potential return), bonds are loans (lower risk, steadier income)
• ETFs bundle many investments into one purchase, providing instant diversification
• Diversification protects against any single investment devastating your portfolio
• Most beginners benefit from starting with broad ETFs rather than picking individual stocks
• The right mix of stocks and bonds depends on your timeline and risk tolerance (covered in Lesson 4-5)
• Use AI to research and compare any investment in plain language

Up next: In the next lesson, we’ll dive into Reading Financial Statements with AI.