Types of Stock & Bond Investments
Different types of stock and bond investments offer investors a choice between capital growth, income and tax advantages. Stocks represent shares issued by corporate entities and are commonly traded on stock exchanges such as the New York Stock Exchange. Investors sometimes buy a mix of bonds and stocks, hoping to achieve their investment goals while safeguarding the capital they invest.
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Common Stock
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Common stock consists of the ordinary shares issued by a publicly listed company. If you own shares of common stock in a company, you are entitled to vote on matters put to the shareholders by the board of directors of the company. Each share of common stock that you own entitles you to one vote. Typically, shareholders vote for a board of directors, and if a takeover bid comes in, common stock shareholders vote to accept or reject the bid. Common stock shareholders often receive dividends from profits, if the board of directors decides to pay a dividend. Ordinary shares can provide capital growth as well as income from dividends if the company does well, but the price can also go down if the company or the markets are not doing so well. The board can also cut or cancel the dividend if the company is experiencing trading or financial difficulties.
Preferred Stock
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Publicly listed companies sometimes issue a type of stock known as preferred stock. Preferred stock represents shares in the company, but preferred stock typically pays the shareholder a fixed dividend that is paid forever, unlike common stock, where dividend payments can be cut back or suspended altogether. Another advantage you get from investing in preferred stock is the fact that preferred stockholders are paid before common stockholders if the company goes into liquidation, if there is money left over from the sale of company assets after creditors have all been paid. In many ways, preferred stock is similar to debt, in that the company has to pay dividends the way it has to pay interest on money it borrows. Because preferred stock dividends are fixed, this can be expensive for the company if dividends fall, but companies do have the right to buy back preferred stock from shareholders to reduce the amount of dividends they have to pay. Investing in preferred stock protects the return on your capital in the event that interest rates fall and offers the chance for capital growth, particularly when interest rates yield less than the dividend paid by preferred stock.
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Corporate Bonds
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Companies sometimes raise money by issuing bonds for sale rather than taking loans from financial institutions such as banks. A bond represents a fixed amount of money that must be paid back at a specific time. The time from the issue of a bond until it is due for repayment is known as the term. Terms can be for various lengths of time, such as one year or five years. The date when capital has to be repaid is known as the bond's maturity date. Corporate bonds typically offer a higher interest rate than bonds issued through government entities, such as the United States Treasury or individual states and municipalities. However, companies may go into liquidation and may not be able to pay back the capital due to bond holders, and the higher interest rates reflect this. You would invest in corporate bonds when you want to earn income from your investment at a higher rate than that offered by banks and government, and if you want a capital repayment at a known, fixed time.
Government Entity Bonds
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Government entities, such as the U.S. Treasury and individual states, along with municipalities, issue bonds to help fund their commitments. The bonds issued by government entities often pay lower rates of interest than corporate bonds -- this reflects the fact that government bonds are less risky than corporate bonds. The perceived wisdom is that government entities are less likely to default on the debt commitment represented by their bonds than a corporation. Another advantage you gain from investing in government bonds is that the income from these bonds is typically tax-free, so you would invest in these bonds to gain a tax-free income with a good expectation of receiving the debt represented by the bonds you hold when they mature.
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