You probably hear a lot about stocks and bonds and know that some people use them to make money, while others aren’t quite so lucky.
But what are these investment tools, how are they different, and how can you know which ones are right for you? The investment world can be confusing, but knowing the foundational differences between these products is the basis for understanding how they work and using them to your benefit.
What Are Stocks and Bonds?
Stocks and bonds are investment vehicles. If you acquire one, you intend to hold onto it for a certain period and profit from it down the road. Investments like these are often used to bolster a retirement portfolio.
But, stocks and bonds are structured differently and make money in unique ways. Knowing these differences is key to maximizing your potential earnings with either of these products.
When you purchase a stock, you’re actually buying a small slice of ownership, or equity, in a company. If the company performs well, the value of your stock will increase over time, allowing you to sell it later for a profit. Companies also typically offer dividends to their investors, which are payments on a quarterly or annual basis based on how well the company performed in that period.
Bonds are essentially a loan you provide to the government or a company. This may sound a little backward, but it’s an old way for institutions, especially the federal government, to get money. You purchase the bond, and the borrowing institution pays you an annual interest rate, just like you would if you were borrowing money from your bank. Then, after a certain period, your loan is paid back.
All investing carries a certain level of risk, so it’s critical to fully understand what you’re purchasing and how it works. Work with an experienced financial professional to make the best decisions for your money.
Just as they make money in unique ways, stocks and bonds have different risks. With stocks, your investment is tied to the company’s performance. If the company performs well, grows, and makes money, the value of your stock increases, allowing you to sell it for more than you paid. Conversely, if the company performs poorly, the value of the stock drops, meaning you could lose money when you go to sell it.
Bonds are typically considered lower-risk, especially if you’re purchasing a bond from the U.S. government or other large institution with long-running credit. However, if you purchase a bond from a company that suffers a big financial loss and is forced to declare bankruptcy, you might not see your loan repaid, or it will be repaid for a fraction of what you lent.
How Stocks and Bonds Work Together
Many investors opt to include both stocks and bonds in their portfolios because they work in different ways and often move in opposite directions.
In other words, if stocks are performing well, bonds are probably lower in price because more people are buying stocks. But, when stock prices fall, or there’s a perceived risk to the market, investors often return to the bond market as a safe haven for their money. Having both stocks and bonds in your portfolio diversifies your holdings, which can protect you from market fluctuations and help maintain your overall financial health.
Learning about investment products can sometimes seem overwhelming and confusing, but knowing more about them can go a long way toward protecting your financial future and ensuring your money is there for you for years to come. Working together with a financial advisor, you can determine if stocks or bonds are right for you.