A Beginner’s Guide: What You Need to Know About Stocks and Bonds
Introduction:
What if you could own a tiny piece of your favorite company — Apple, Tesla, even Netflix? Or, how about if you could lend the government money while receiving steady returns in the process? That’s precisely what stocks and bonds enable you to do.
Investing is not simply selecting a few stocks at random and hoping they will perform well. It’s about knowing how different kinds of investments work, how to handle risk and how to make smart moves that help your money grow over time.
In this extended guide, we’re going to break down two popular options: stocks and bonds. By the end, you will know how they work, their risks and rewards, and how to pick one that is good for your investment goals.
What Are Stocks?
A stock signifies ownership in a corporation. When you buy a share of a company, you are really buying a piece of that company. Your stock price will go up and down depending on the success of the company as well as other market elements.
From that perspective, consider this: If you hold stock in Apple, you own a portion of that company. If Apple performs well, its stock price appreciates — and so does the value of your investment. If it falters, your stock price could drop.
Types of Stocks:
Common Stocks – This is the most common form of stock. Shareholders can get dividends (a cut of the company’s profits), but there’s no guarantee. However, common stockholders typically carry voting rights in the company.
Preferred Stocks – These type of stocks behave similar to bonds. Investors are paid fixed dividends before common stockholders share. But holders of preferred stock typically lack voting power.
How to Make Money With Stocks?
Capital gains: If you sell a stock for a higher price point than at which you purchased it, then you profit. This is known as a capital gain.
Dividend: You may have investment in a dividend-paying company, which gives you a regular income.
Growth: Stocks that you hold for a very long time will continue to appreciate over that period.
Risks of Investing in Stocks:
Market volatility: stock prices rise and fall by company performance, economic conditions and investor emotion.
No Guaranteed Returns: Unlike bonds, stocks don’t come with a guaranteed return.
Risk of Loss: You can lose money if the company does poorly.
What Are Bonds?
Bonds are like IOUs. Price: When you purchase a bond, you are essentially lending money to a corporation, state, or entity in exchange for periodic interest payments over a certain amount of time.
Now imagine you loan the government $1,000. In exchange, they agree to pay you a guaranteed interest rate (for example, 5 percent) per year for a period of 10 years. After the end of the 10 years, they pay you back your original $1,000. That’s how bonds work.
Types of Bonds:
Government Bonds: Considered the safest type of bonds, these are issued by governments. For instance, U.S. Treasury bonds are government-backed and represent virtually no risk.
Corporate Bonds: Issued by corporations, these bonds often provide higher yield than government bonds but also carry higher risk.
Municipal Bonds: These bonds are issued by a city, state or local government and often come with tax advantages.
How Do You Earn Money from Bonds?
Interest Payments: Bondholders get periodic interest payments (referred to as coupon payments).
Capital Gains: The price of bonds can increase before their maturity.
Holding Until Maturity: You’ll receive your initial investment back when the bond matures.
Risks of Investing in Bonds:
Interest Rate Risk: Bond prices generally decrease as interest rates rise.
Inflation Risk: If inflation rises faster than the bond’s interest rate, your real returns decline.
Default risk — Some bonds, particularly corporate bonds, come with a risk that the issuer won’t repay the loan.
Stocks or Bonds: What’s Right for You?
Stocks and bonds each have their pros and cons. Here’s how they compare:
Stocks Bonds High (volatile prices) Low (stable income) Capital gains, dividends Interest paymentsFeatureReturn Potential High over the long term Lower but more predictableIncome TypeGrowth investors, long term wealthStability, fixed income, low riskBest For
Your risk tolerance and financial goals will dictate which investment option is right for you. If you seek higher possible growth and have the stomach for some volatility, stocks may be suitable for you. If you like steady returns and less risk, bonds might be a safer bet.
How to Begin Investing in Stocks and Bonds
If you’re prepared to make an investment, here’s how:
Set Your Investment Goals
Are you saving for retirement?
Do you want passive income?
Are you saving for something big in your life?
Determine Your Risk Tolerance
If you can accept market highs and lows, you may want to allocate more towards stocks.
If you want more stability, try a larger portion in bonds.
Open an Investment Account
For Stocks & ETFs: Use them to buy stocks and ETFs, like Robinhood, E-Trade, or Fideliity.
For Bonds: TreasuryDirect (for government bonds) or Vanguard (for bond funds).
Start Small and Diversify
Don’t pour all your dollars into a single stock or bond. Diversifying Your Investments
To diversify these easily, consider ETFs and mutual funds.
Try to keep learning, and be patient with yourself.
Stock prices change every day—don’t freak out.
For maximizing growth, reinvest dividends and interest payments.
Investing is a long-term game, so stay the course.
Wrap Up: Constructing a Shrewd Portfolio
A portfolio comprised of a mix of stocks and bonds tends to be best for beginners. This way you can have the growth potential of stocks and the stability of bonds by using a diversified portfolio.
So it’s May 2022 and you’re 25 and just getting started. An allocation of 70% stock to 30% bond might be about right. If you’re nearer to retirement, you may transition to a mix of 50% stock and 50% bond to help mitigate risk.
Whether you’re just starting out on your investing journey or are a seasoned pro, what you need to do is get started. The earlier you invest, the more time your money has to compound.
So, what’s stopping you? So, get started, open an account, and start persisting and accumulating wealth!