Stocks and bonds are two of the most common investment types. Individuals usually possess both asset types in their investment portfolios. There are distinct differences in investing in stocks versus bonds. Stocks represent ownership in a company and bonds are essentially a type of loan given to companies and governments. Advantages and disadvantages exist in stock and bond investing. Investors should know the characteristics, risks and benefits of both asset classes to make solid investment decisions.
Stock Investing Characteristics
When you invest in a stock, you obtain ownership rights within a company. When compared to bonds, stocks are typically considered a riskier investment. Stocks are sold by the share. Many online brokerage firms allow you to purchase one share of stock. The value of a stock is typically dependent on the financial performance of a company. When a company experiences a positive financial performance, the value of the stock usually increases and it decreases when a company experiences a negative financial performance. Depending on performance and company policy, some companies reward shareholders by paying dividends.
Stock Investing Pros and Cons
As opposed to other investments such as certificates of deposits (CDs) and bonds, stocks can potentially offer investors high rates of returns. Also, when you purchase stocks for cash, you can only lose the principal amount of your investment. This means that a limit is on the amount you can lose, so you know your maximum risk when purchasing shares of stock. The majority of stocks offered on major stock indices are very liquid, which means you can easily move in and out of your stock positions. A disadvantage of investing in stocks is that in the case of a company's financial insolvency, common shareholders are paid last on the list of creditors. Another disadvantage is that the ownership rights of shareholders are very limited. In most cases, stockholders cannot make major decisions in a firm.
Bond Investing Characteristics
There are several types of bonds -- corporate, government and municipal bonds. Companies and governments borrow money from investors by issuing bonds. A bond may sell at a discount or premium of face value. A company pays the investor interest on the bond at the specified time in the bond agreement until the maturity date. Companies usually make interest payments semi-annually. In most cases, the value of a bond moves in the opposite direction of interest rates. When interest rates rise, the value of a bond falls. When interest rates decline, the value of a bond increases. Although the interest rate is fixed, a bond can experience a negative rate of return.
Bond Investing Pros and Cons
An advantage of bonds is that they are generally safer assets than stocks, but also offer lower returns, for the most part. Investors nearing retirement age usually invest more in bonds than stocks because of their lower risk. Municipal bonds offer investors the benefit of not paying taxes on interest payments. A disadvantage of investing in bonds is that the issuer can call back the bond before the due date. This usually happens when a company wants to avoid paying high interest rates when bond rates are low.
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