One of the most basic investment tools is understanding what stocks and bonds are and how they may fit into your portfolio.

Stocks are the cornerstone of every investment portfolio (except for a few specialists who specialize in “junk bonds”, but they need not concern us). A share of company stock is a literal piece of ownership of that company, and therefore when you buy a stock share you get the right to a claim on a part of the company’s wealth. The number of share that you own versus the total number of shares the company has put up for sale, called “shares outstanding”, determines the total percentage of ownership you have in that company.

Common stock allows holders to participate in shareholder meetings and vote on company decisions. Preferred stock does not allow this privilege; however, preferred stock gives its owners other benefits. Preferred stock holders typically receive company dividend payouts before common stock holders, and should a company go bankrupt or need to liquidate itself preferred stockholders would be paid before common stock holders, meaning they have less chance of losing all their stakes in the company.

A given stock’s price–and thus how much it is worth–is driven up or down by a complex set of factors that often don’t seem to make any sense. Basically, however, a stock’s price reflects what the general investing public is willing to pay for it.

The reason that stocks are the cornerstone of virtually every investment portfolio is that historically they have given the highest returns over time than other investment vehicles, and there is a vast array of diversification potential in stocks, allowing investors to make great use of them in balancing their portfolios for risk factors and for shorter and longer term goals.

However, the vast majority of investors also include some bonds in their investment portfolio. Typically, bonds are used for “hedging”. When investors “hedge”, they seek to balance out or minimize greater risk in one sector of the financial world with something less volatile, less complex, or at the other end of the economic spectrum from their core investment portfolio.

Bonds are literally investments in debt. When you buy a bond, what basically happens is that you as the investor lend money to a private company or a government. The government or the company agrees to pay you back the money plus a certain interest rate in a given period of time or, that is, until the bond’s “maturity date”. Bonds are issued to raise money to finance any number of new projects or activities, and their maturities range anywhere from a mere 90 days with government treasury bills to the 30 years of the government bond. Typically, however, investors do not invest directly in bonds but in funds that are, in their turn, financed by the active buying and selling of bonds on the open financial market.