Difference Between Stocks and Bonds
Investing is n’t as difficult as most people think , but there is a lot of jargon to learn. Stocks and bonds are two general terms that come to mind when you think about investing. Many people don’t know the difference, so we’ll break it down.
Stocks buy property, bonds buy debt
For most of us, the dream of retirement means investing money so it can grow over time . While there are certain types of investments, stocks and bonds are two general categories that you should invest in.
In general terms, shares are part of the ownership of an individual company. This is also known as fairness . When a company goes public, such as Microsoft, Google or General Motors, they sell shares of their business to the public. You buy a share, the company gets your money to grow its business, and in turn, your share is a small fraction of the ownership of the company. If a company has done well, like Google has done for many years , it makes a profit and your shares of ownership increase in value. If the company fails, as it did with Volkswagen lately , your stock falls in value (or worse, you lose it entirely).
Of course, if a company is doing well, you can expect its stock to be worth more. A single Google share will cost you over $ 800 right now, while a stake in Volkswagen is now worth less than $ 150. These numbers change over the years, depending on how the company operates.
And then there are bonds. When you buy a bond, you are basically buying debt and lending money to the company (or government). Instead of investing in the company itself, you give them money and they agree to pay you interest. This interest is called a “coupon,” and it is paid at a set rate and on a set schedule. A bond also has a maturity date: the date on which the issuer must repay the amount it borrowed. You can also sell your bond before the maturity date. Depending on what the interest rates look like when selling, you may get more or less than what you paid.
Because bonds are predictable in this way, they are called fixed income securities . Investopedia explains :
For example, you buy a bond with a par value of $ 1,000, an 8% coupon, and a maturity of 10 years. This means that you will receive a total of $ 80 ($ 1,000 * 8%) per year for the next 10 years. In fact, since most bonds pay interest semi-annually, you will receive two payments of $ 40 a year for 10 years. When the bond matures in ten years, you will get your $ 1,000 back.
You won’t earn huge interest, but you more or less know what you get with the bond . In short, when you buy stock, you buy stock, and when you buy a bond, you buy debt.
Stocks are considered more risky investments than bonds
When you buy a stock, you can make a big profit if the company does well and your stock grows in value. For example, if you bought a Google share in 2004, you paid $ 50 per share. Three years later, in 2007, the same share was valued at about $ 300. If you sell your stake, you will make a $ 250 profit. Not bad. If you wait until 2017 to sell, your share will be valued at approximately $ 850, so you will make a profit of $ 800 per share. Good! However, most people don’t buy just one share. So, if you bought 50 Google shares back in 2004 (which would have cost you $ 2,500), those same shares would now be worth over $ 42,000. You can see that stocks are a great way to multiply your retirement savings.
Again, not every company is Google.
There are many factors that can affect a company’s profitability, from testimonials to new technologies and how consumers choose to spend their hard earned money. For this reason, stocks are generally considered the riskier investment, especially in the short term. However, in exchange for the risk, you will receive more rewards. For example, according to the investment site Zacks , from 1959 to 2008, stocks brought in about 9.18% per annum, and the annual yield on bonds over the same period was 6.48%.
Of course, this is a generalization, and stock performance will vary greatly from company to company. That’s what the S&P 500 is for. It is a financial index of the 500 most economically powerful companies in the United States. Their value may fall or rise from day to day, but these companies have performed quite well over the years, which makes them less risky in the long run as they hold their value fairly consistently. It’s also worth noting that investing all your money in one company is a bad idea . Most experts recommend mutual funds , a group of investments in several different stocks.
Again, you more or less know what you get with bonds. They are considered a safer investment than stocks, but they do little money. If all of your retirement savings are in bonds, you probably aren’t going to earn much over the years.
However, as you approach retirement, you will want to invest less in stocks and more in bonds . You don’t have much time to take risks.
How much should you invest in both
Aside from stocks and bonds , there is a lot more that can be done , but these are the main, common types of investments that you should have in your portfolio. So how much should you invest in each category? It depends on your age, investment goals, and risk tolerance, but here’s a general rule of thumb:
110 – your age = the percentage of your portfolio that should consist of stocks
So, if you are 30, you would invest 80% of your portfolio in stocks (110-30 = 80), and the remaining 20% in bonds with lower risk. However, if you are more conservative, you can invest 30% in bonds instead. It’s up to you, and some people think this is too conservative, but it’s a good starting point.
As you get older, you should adjust these percentages accordingly. If you follow the 110 rule above, you will want to buy more bonds when you turn 40 so that you have 30% bonds instead of 20. The closer you get to retirement, the more stability you need in your investment. In other words, you don’t have much time to take risks. If your stocks crash, you have many years to wait until they bounce back again.
There are also many tools to help you determine how much to invest in each. The Bankrate Asset Allocation Calculator works well, or you can use a full featured investment tracker like Personal Capital .
Of course, investing requires a lot more. There are different categories of stocks and bonds. There are different ways that stocks are paid to their shareholders. However, these are the basics, and if you are a budding investor, it is important to understand the difference in how these two main assets work in order to grow your nest egg over time.