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What are investments all about?
When you make an investment, you are giving your money to a company or enterprise, hoping that it will be successful and pay you back with even more money.
Stocks and bonds
Many companies offer investors the opportunity to buy either stocks or bonds. The following example shows you how
stocks and bonds differ.
Let’s say you believe that a company
that makes automobiles may be a good investment. Everyone you know is buying
one of its cars. Plus your friends report that the company’s cars rarely
break down and run well for years. You either have an investment professional
investigate the company and read as much as possible about it, or you do it
yourself. After your research, you’re convinced it’s a solid company
that will sell many more cars in the years ahead.
The automobile company offers both stocks
and bonds. With the bonds, the company agrees to pay you back your initial
investment in ten years, plus pay you interest twice a year at the rate of 8% a
year.
If you buy the stock, you take on the risk
of potentially losing a portion or all of your initial investment if the
company does poorly or the stock market drops in value. But you may also see
the stock increase in value beyond what you could earn from the bonds. If you
buy the stock, you become an "owner" of the company. You’ll only make
money, if the company makes profits.
You wrestle with the decision. If you buy
the bonds, you will get your money back plus the 8% interest a year. And you
think the company will be able to honor its promise to you on the bonds because
it has been in business for many years and doesn’t look like it could go
bankrupt. The company has a long history of making cars and you know that its
stock has gone up in price by 12% a year, plus it typically paid stockholders a
dividend of 4% from its profits each year.
You take your time and make a careful
decision. Only time will tell if you made the right choice. You’ll keep a
close eye on the company and keep the stock as long as the company keeps
selling a quality car that consumers want to drive.
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The Main Differences Between Stocks and Bonds
Bonds
The company promises to return money plus interest.
Risk: If the company goes bankrupt, your money may be lost. But if there is any money left, you will be paid before stockholders.
Stocks
If the company profits, its stock may go up in value and pay dividends. You may make more money than from the bonds.
Risk: The company may do poorly, and you’ll lose a portion or all of your investment.
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