Understanding Investing in Stocks and Bonds
By buying bonds, investors are lending money to companies or governments. In return, bond holders receive regular, fixed payments until the bond matures. Stocks, on the other hand, make their holders part owners of a company, and entitle them to a share of profits. Stocks are considered riskier but potentially more profitable investments than bonds.
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Bonds
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One way for companies or governments to raise money is to issue debt obligations in the form of bonds. Holders of bonds receive regular fixed payments of interest, and at the end of the maturity period, the principal. Small investors can trade in bonds either directly or through a brokerage service. U.S. Treasury bonds are the most popular, and most investors consider them the safest.
Bond Issuers
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Corporate bonds pay higher rates of interest than local or national government bonds, but they are usually riskier because companies are more likely to default on their debt obligations than governments. In addition to risk factors, bond investors need to think about tax issues. In the United States, corporate bond payments are not tax-exempt, while Treasury-- government--bonds are taxed only at the federal level. Some bonds, such as Series I and Series EE, can be tax-free if the interest payments are used to pay for college tuition. Holders of municipal bonds do not pay federal, state or municipal taxes if they are residents of the issuing authority's state.
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Stocks
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Another way for a company, but not a government, to raise money is to issue stocks. This way the company does not have to pay back the money it gets and there is no interest. This is because by issuing stock, a company gives others part ownership and sometimes has to share its profits with them. Stockholders have a right to know how the company is run and they have a say in who actually runs the company. The more shares they own, the bigger their say.
Dividends
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When a company makes profit, it can decide to reinvest all of it into further expansion, or it can share some of the profit with the stockholders in the form of dividends. Larger and more stable companies usually pay dividends, while smaller ones prefer to reinvest their earnings. Whether a company pays dividends or not does not have a direct effect on its stock price.
Stock Exchange
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Sometimes, a company offers stock directly to its staff, through stock options. More commonly, stocks are traded on a stock exchange, where anybody can buy them. Investors trade in stocks through a broker, who has access to a stock exchange and who executes the client's orders. Some stock exchanges, such as Nasdaq, are purely electronic, while others, such as the New York Stock Exchange, still have trading floors where buyers meet the sellers. Stock prices change several times a day, based on investors' expectations regarding a company's future.
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- Photo Credit stock exchange image by Christopher Walker from Fotolia.com
