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Stocks vs. Bonds

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Authored by Geoff Vaughan in Stock Trading 
Published on 03-20-2009

There has been a lot of focus lately in the media on investments and how much of a beating they’ve been taking. The question that remains in many investors minds is whether to trust the stock market any more, since the annual rate of return of the Dow Jones Industrial Average over the past ten years is actually a negative number. That’s a long time to wait to just end up losing money. So many people are wondering just where to put their money these days, and bonds are one investment vehicle that comes to mind.

A share of stock, also known as a security, is defined as a piece of a company. When you own a stock, you are the owner of a percentage of that company, and you typically have voting rights that go along with your ownership. You usually vote each year for the election of a board of directors, and there may be other issues that come up on which you can vote as well. In addition, the company may pay a dividend to each shareholder. It’s usually a small percentage of the worth of each share, but it all goes toward the rate of return of the investment. The primary way a stockholder looks to make money from securities is through share appreciation. If the price per share rises enough, the owner can sell this piece of the company for a higher price than he paid for it, making money in the process.

Bonds, on the other hand, are like loans. By purchasing a bond, an investor is buying some debt from that organization, for an agreed-on interest rate that is payable to that investor. Organizations issue bonds to raise money for various things, and it’s not just companies that do this – governments issue bonds as well to pay for many different types of projects. Bonds can also be bought and sold on the open market, not just from the original issuer. These prices can change value depending on lots of factors such as how stocks are doing at the time and the credit rating of the issuer, so price appreciation is also a factor in these investment vehicles. Bonds are generally seen as safer investments than stocks. Certainly, their prices are less volatile, especially in today’s stock market conditions. But also, bond holders are usually higher up in the hierarchy of creditors than stock holders should the company go bankrupt. That means that any money made by liquidating the assets of the company, after being paid out to those holding accounts receivable, will go to the bond holders first before being distributed to the shareholders. Rarely, if ever, does any money filter that far down after a bankruptcy.

The true difference between stocks and bonds is the age-old debate of risk vs. reward. Putting money into stocks has the potential to make the investor more money than investing in bonds; however that person is that much more likely to lose his shirt in the deal. Bonds are usually the safer bet, but then the name of the game is to make a lot of money, right? In the end, a good mixture of stocks and bonds is the right way to balance out the average investor’s portfolio.

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