Two important investment terms to be familiar with if you’re seriously considering making long-term investments in the stock market are stocks and bonds.
What is a Stock?
The shares of a company that you own are called stocks, and these usually offer the highest returns.
“In investing, what is comfortable is rarely profitable.” – Robert Arnott
However, when you invest most of your assets in stocks, you also stand to lose the most amount of money. You can easily lose up to half the money you invest in stocks in any given year. Stocks are riskier but, at the same time, potentially more rewarding.
What is a Bond?
Bonds, on the other hand, are securer investments since they’re essentially just loans you give to companies when you invest in them. Like any loan, you get the entire amount back over time, along with interest. The returns on bonds are less than on stocks, as are the potential amount of risks.
“The individual investor should act consistently as an investor and not as a speculator.” – Ben Graham
Should You Invest in Stocks or Bonds?
If you feel comfortable with the risk of losing half of your yearly investments, stocks are the right option for you. If you have enough disposable income to be able to afford losing half of your investments and still manage to live comfortably, stock investments will offer the highest potential return on both short-term, as well as long-term investments.
Asset allocation is finance guru-speak for figuring out how you should divide your investments amongst bonds and stocks.
Stocks tend to earn more than bonds, especially when you factor in long term investment. If the company, whose stock you hold, grows exponentially, then the value of your stock getting you handsome returns on your investment. For someone willing to take the risk, stocks can earn more, and most company’s stocks keep rising.
You are taking a risk, though, as there are no future return promises to your initial investment. You can just as easily lose all the money you invested. The stock market is unpredictable, and if you do not know what you are doing, then you can lose money easily by investing in the wrong stocks.
Bonds, on the other hand, are often considered a lower risk option because they offer a fixed rate of interest on the money you invest. They are also safe when the economy keeps changing because the option of fixed-rate bonds makes them resilient to interest rate fluctuations, and you still make the same amount as you would with the economy booming.
The income isn’t as high as stocks, which is why many people are more drawn toward stocks. But, if you are not ready for risks and don’t mind lower-income potentials, then bonds are a safe bet, to begin with.
Stocks mean high risk but also high turnover, bonds mean low risk but also lower turnover – this is the main difference you need to know. Now, the choice depends on you and what your financial goals are.
“Wide diversification is only required when investors do not understand what they are doing.” – Warren Buffett
If you want to have a long-term plan and don’t care much about short-term market fluctuations, then stocks can be a good option. If you want to play it safe and don’t worry about interest rate fluctuations, then bonds can be a good starting point.