Investing your hard-earned money into portfolio investments like stocks and bonds can feel intimidating, as there’s no guarantee you’ll receive a return on your investment. And there’s also the chance you may lose your initial investment, as well.
In the realm of financials investments, there will always be risk involved, yet investments are still powerful tools in asset management, which can offer you the potential of having your money work for you.
Depending on your individual financial goals and your stage of life, financial planning advisors often encourage investing in both stocks and bonds to balance your risks with probable rewards. Understanding the difference between stocks and bonds and their advantages and disadvantages can help you make the right choices to achieve your financial goals.
What Are Stocks?
Stocks are purchased shares of a company that grant the investors part ownership in the business (often referred to as equities). When a company is looking to acquire capital for expansion, renovation, debt payment, etc., they take their business from being private to being public by offering shares in the company to potential investors. When an investor purchases a stock, they become a stakeholder for the company, and typically, the company gives its stakeholders the privilege of voting in company affairs, such as policy changes.
While stocks typically have a greater opportunity to earn more money than bonds, they are considerably riskier investments. Like any investment, there are both advantages and disadvantages, and in the stock market, they come in the form of capital rewards or risks.
Rewards—How Stocks Can Earn You Money
- Appreciation: At any point in time, the value of your stock can appreciate (i.e. the value of your share increases). If a company is doing well, you may see your share’s value increase. For example, if you purchase a share for $500, and the company is growing and having success, you may see your individual share increase in value from $500 to $750. By selling your share at this point, you would earn a 50% profit on your share. Because of this potential increase in value of a share, stocks are considered to offer a higher potential return on investment than bonds.
- Dividends: One perk of purchasing stocks is receiving dividend payments. Dividends are regular payments made by the company from their earnings to shareholders. Not all stocks pay dividends, however.
Risks—What’s at Stake When Purchasing Stock?
- Depreciation: Just as the value of your stock can appreciate at any time, it can also depreciate (i.e. the value of your share decreases). This typically occurs when a company faces a certain hardship or setback. Depending on how the company does, you risk losing some or all of your investment by your share decreasing in value. If you choose to weather the stock-market storm, it’s possible that the value will increase again, as the market is constantly moving.
- Last on the Docket. If something should happen to the company, and it goes under, stockholders are often the last to get paid, so you may not receive a return on the purchase of your share.
What Are Bonds?
Bonds are essentially loans issued by investors to an entity (e.g. corporate, government, etc.) looking to borrow money for growth, purchasing property, debt payment, etc. When a bond is issued, a company agrees to repay the bondholder (i.e. investor) the loan amount, along with variable or fixed interest within a certain period of time.
Considerably a safer investment, bonds have less risky disadvantages than stocks, and therefore, bondholders may see less of a total return on investment when compared to the potential growth of a stock share.
Rewards—How Bonds Earn You Money
- Interest Earned. What makes a bond a conservative investment choice is the guaranteed interest a bondholder will earn. The bond issuer agrees to make interest payments to the bondholder until the loan matures, and the principal loan amount is paid off.
- First on the Docket. If a company should go under, bondholders are often one of the first “loose ends” to get paid. Outstanding debts are typically the first to be paid off, further securing the benefit of investing in bonds.
Risks—What’s at Stake with Bonds?
- Company Default. While rare, it’s possible that a company can default on its payments to its bondholders. If this happens, lenders are at a risk of losing their investments.
- Effects of Inflation. When a bond has a fixed-interest rate, it’s possible that inflation can influence the potential return from interest over the life of the loan. According to an article in The Motley Fool, “Imagine that you purchase a bond with a 4% interest rate. You’ll make money in the long run if the rate of inflation stays below 4% over the life of the bond. But if inflation rates rise to 5%, you’re locked in at that lower 4% interest rate and you’ll actually lose money over the long run.”
Trust Focus Financial with Your Investment Planning
When making investment-planning decisions, it may be beneficial to speak with an independent financial advisor who can offer portfolio management expertise and advice, assuring you make well-informed decisions.
At Focus Financial, our team of investment management professionals will work with you to understand your unique situation and financial objectives, showing you whether investing in stocks and/or bonds will best help you achieve your goals. To learn more about our asset management services and to begin building your individualized investment portfolio, contact Focus Financial, and we’ll help you find an independent financial advisor near you.
