Bond Versus Stock
Bond and stock investments are the most familiar to most people. Assuming a stock or bond is a good buy, which is best depends on what the investor wants to accomplish. Both generally offer good earnings but there is always some risk. It's important to understand the merits and disadvantages of both types of securities in order to make wise investment choices.
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Identification
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When you buy shares of a company's stock you purchase part ownership of the company. You gain the rights (and risks) of ownership, including dividends (if any) and for common stock the right to vote at stockholders' meetings. Stocks are priced anywhere from a few cents to several hundred dollars per share. Bonds (whether issued by corporations or government agencies) are debt instruments the issuer uses to borrow money. Bonds have maturities, usually of 1 to 30 years, after which they must be paid off by the borrower. Bonds pay a specified sum (called the coupon rate) each year. Corporate or municipal bonds which individual investors buy usually have par values (the amount the borrower must repay) of $1000 or $5000, but the price will vary depending on market conditions. You don't share in ownership as with stock. You are simply lending the company money.
Function
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Stock shares are either common or preferred. Common shares tend to rise in value if the company does well, and fall if it doesn't. Preferred stock is a cross between bonds and common stock. It pays higher dividends, which many companies pledge to maintain as far as possible. In the event the company is liquidated, preferred shares are paid off first. Generally, they do not have voting privileges and their price is far more stable, but don't appreciate as much compared to common stock.
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Significance
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Corporate bonds have les risk than common stock and pay a guaranteed income. The price of the bond isn't likely to increase unless interest rates fall substantially. For individual investors, the government bonds of most interest are municipal bonds (issued by state and local governments). They are issued mostly in $1,000 or $5,000 denominations. The main difference compared to corporate bonds is that most are exempt from taxes. They usually pay lower rates than corporate bonds, but the tax exemption makes them attractive to investors in high tax brackets.
Features
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Common stocks and bonds vary in price for different reasons. If company earnings grow, the stock is almost certain to rise over time. The price of bonds depends on the prevailing interest rates. If interest rates rise, a bond becomes less attractive because it pays a fixed rate and the price will fall. Conversely, if interest rates fall, the bond price is likely to rise. Bonds are rated based on risk (how likely it is the issuer will be able to repay the bond at maturity). A reduced rating will usually cause the bond's price to fall. These features apply to all types of bonds.
Benefits
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The nature and behavior of stocks and bonds make them good investments, but for different purposes. A blue chip bond is a very low risk investment that provides good income. It will not make your portfolio grow in value, or at least not by much. Bonds are a way of diversifying an investment portfolio and reducing risk. They are well suited to retirees who are more concerned with income than equity growth. Stocks carry greater risk and dividends, if any, are almost always much less than bond yields. With stocks you have the opportunity for substantial growth in your equity, making them attractive to investors seeking growth rather than immediate returns.
Considerations
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Intelligent investing in stocks or bonds requires you know about the issuing entity, whether a corporation or a government. You will focus more on growth potential when researching a stock, but otherwise, you want some basic criteria met. The issuer should have a history of good financial performance. The current financial status should be solid. Look at corporate annual reports, bond ratings services, and independent analysts. Revenues and earnings should be adequate to meet debt obligations and/or finance future growth.
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