By Bryan Trugman, CFPⓇ
With proper budgeting and a suitable investment account, you’re already on your way to a successful investment journey. However, you need to identify and invest in the right assets to stay profitable and increase your chances of reaching your investment goals in the long run.
Stocks and bonds provide great investment opportunities to help you make the most of your investment capital. Both securities offer a blend of various risk and reward profiles, creating the potential for growth in your wealth over time. Here, let’s consider the basics of investing in stocks and bonds and how to determine the most suitable plan for your long-term financial goals.
What Are Stocks?
Think of stocks as tiny slices of ownership in a company. Purchasing the stock of a company makes you a shareholder, meaning you own a piece of that company. While companies issue shares of stocks to raise funds, investors purchase stocks to benefit from companies’ assets and earnings.
How Stocks Work
Companies sell stocks as shares on stock exchanges such as the New York Stock Exchange (NYSE) or NASDAQ. They make their shares available to the public through an Initial Public Offering (IPO) or by selling the shares in the stock market.
When you purchase stocks, you’re entitled to a share of the company’s profits in the form of dividends. You can also make a profit by selling your stock for a higher price when it appreciates in value.
How long you hold the stocks before reselling depends on your investment strategy. You may hold the stocks for the long term while you benefit from dividends and capital appreciation; alternatively, you can leverage short-term price fluctuations to resell the stocks at higher prices to make a profit.
The price of a stock rises or falls depending on the company’s performance, which influences how interested people are in their shares. When a company is performing well, the value of its shares usually rises. Similarly, the price may likely fall when there’s a decline in their performance.
Other factors that may influence the price of stocks at a given time include:
- Supply and demand
- Market news and trends
- Economic factors such as GDP and inflation
- Currency exchange rates
What Are Bonds?
Bonds are debt securities issued by governments, corporations, or other entities to raise capital. When you buy a bond, you’re lending money to entities that pay you periodic interest payments in return, plus your initial investment when the bond reaches its maturity date. Bonds are generally considered less risky than stocks and are often used by investors to add stability to their investment portfolios.
How Bonds Work
A bond consists of three major components: face value, coupon rate, and maturity date. The coupon rate is the interest rate you earn on bonds while the face value represents the amount you receive when the bond reaches maturity. Maturity dates range from a few months to several years.
Let’s illustrate how bond earnings work with an example. Assume you purchase a bond for $5,000 with a maturity period of 10 years and a coupon rate of 4%. If you hold the bond until it matures at 10 years:
- You’ll get back $5,000.
- You’ll get back 4% interest, or $200, a year.
- Your return will be about $2,000 over 10 years ($200 x 10).
While bonds are often seen as a low-risk investment compared to stocks, it’s important to remember that they’re not completely foolproof. If you choose to sell your bond before its maturity date, you could end up receiving less than what you paid for it. Additionally, if the issuer of the bond defaults on their payments, you could lose money as well. As with any investment, it’s crucial to thoroughly research the risks and rewards before making a decision.
Key Differences Between Stocks and Bonds
From risk and return to maturity and payment, stocks and bonds differ in several ways. Properly understanding these key differences can help you choose the one that best aligns with your financial goals and risk tolerance.
- Ownership vs. Lending: Buying stocks makes you a shareholder of a company. As a shareholder, you have ownership in the company—and voting rights in some cases. Your returns come from share price appreciation and, in some cases, dividends. With bonds, you receive interest payments for lending money to a bond issuer, which can be a government or corporation.
- Risk and Return: Stocks usually offer higher potential returns than bonds, but also come with higher risk. Stock prices can be volatile and fluctuate significantly, especially in a short window of time. Bonds are safer compared to stocks since they offer a fixed income stream and return of principal at maturity. However, their returns are usually lower than stocks. Having the appropriate blend of stocks and bonds is crucial for striking the right balance of risk and reward for your portfolio.
- Income vs. Capital Appreciation: People invest in stocks primarily for capital appreciation since they don’t usually provide a fixed income stream. However, some stocks do offer dividends, which can vary based on company performance. Stock investors hope to resell the stocks when their price increases in time. On the other hand, bonds can provide a stable means of regular income. The interest rate is fixed, so bondholders know how much they will get.
- Maturity: You can hold stocks for as long as you want as they do not have maturity dates. For bonds, there’s always a fixed maturity date when the issuer repays the principal bond amount.
- Volatility: Bonds were traditionally considered less risky since their prices are influenced by less volatile factors such as changes in interest rates and issuer creditworthiness. However, the trend has changed in recent times, with policy changes and rapid sales of bonds by the U.S. government drastically increasing the volatility of bonds.
Stocks vs. Bonds: Make the Right Investment Choice
Both stocks and bonds offer unique features, benefits, and risks. Sometimes it can be challenging to decide which is most suitable for your investment goals. This is where partnering with a financial advisor comes in.
Attitude Financial Advisors is dedicated to helping you make informed investment decisions tailored to your financial goals. Book a free consultation with me via call at (516) 763-7603 or contact me via email at firstname.lastname@example.org for proper investment guidance. I look forward to speaking with you!
Bryan Trugman is a managing partner, co-founder, and a CERTIFIED FINANCIAL PLANNER™ practitioner at Attitude Financial Advisors. With more than 15 years of experience, Bryan specializes in addressing the financial needs of new parents as they seek to realign their finances, assisting divorced individuals as they navigate an unforeseen fork in the road, and strategizing with those seeking to accrue a dependable retirement nest egg. Bryan is known for being a good listener and building strong relationships with his clients so he can help them develop a customized financial plan based on what’s important to them. He is passionate about helping his clients experience financial confidence so they can worry less and play more. Bryan has a bachelor’s degree in industrial and systems engineering with a minor in mathematics from State University of New York at Binghamton. He has served on the board of the Financial Planning Association and continues to be actively involved in the national organization. He is also a member of the Plainview-Old Bethpage Chamber of Commerce and has served as its vice president and as a board member. When he’s not working, you can find Bryan on the ballroom dance floor or engaged in a fast-paced game of doubles on the tennis court. To learn more about Bryan, connect with him on LinkedIn. Or, watch his latest webinar on: How Much Is Enough? A Surprisingly Simple Way to Calculate Your Retirement Savings Needs