A stock is an investment; when you purchase a company’s stock, you’re purchasing a small piece of that company. The piece that you purchase is called a share. When you own stock in a company, you are a shareholder because you share in the company’s profits or losses. As a shareholder, you technically are part-owner of the company; therefore, you receive certain voting rights within the company. When shareholders purchase stock, it benefits the company by raising capital. Companies, such as UPS, Apple, Pepsi, Ford, or any other public company in the world, grow and invest this capital into products for the company’s growth. As the company grows and prospers, the shareholders participate in the growth of the company either in the form of a higher stock price, or as a quarterly dividend. For investors, stocks are a way to grow their money over the long-term and provide a hedge against inflation.
Investors purchase stocks in companies they think will go up in value; if that happens, the company’s stock price per share rises in value as well. The stock can then be sold for a profit. Purchasing a stock can be riskier than purchasing a bond, mutual fund, or ETF, but the reward can be greater as well. Stock prices change by the minute during the day. Typically, stocks are known to be bullish over a longer duration; or in layman’s terms, stocks tend to rise over a longer time period. When the stock goes up overtime, and the investor sells the stock at a higher price than what he paid for the stock, there is a capital gain. A rise in the stock price is the most common way to make money in a stock, but you can also make money through dividend income. Dividends are the cash payments made to the shareholders for sharing in the profits of the company. A dividend is typically paid quarterly to shareholders. Mature companies with a long history of paying consistent dividends, like Pepsi, will typically raise their dividend over time. Pepsi is a value company stock. Growth stock companies do not usually pay a dividend; although, growth companies typically have higher gains, or rising prices. Growth companies focus on ploughing all its cash back into the company, to grow the company (hence the word growth stock). A good investment should earn an average of approximately 7%-10% per year.
Think of a bond as a loan. When you buy a bond, you’re purchasing a loan to a company or government that pays back a fixed rate of return. It is a safer investment than stocks, but still has risk. Bonds generally require minimum investments, typically bought in $1,000 increments. The investor or lender receives semi-annual income, or a coupon, in return for buying the bond. Unlike a stock that typically pays quarterly dividends, bond funds usually pay interest income to you on a monthly basis. Bonds are inversely correlated to interest rates; when interest rates go up, bond prices go down. A good bond investment should earn an average of approximately 2%-5% per year.
There are many different types of bonds which you can buy; the safest bond would be a US Treasury bond, because it is backed by the guarantee of the U.S. Federal government. Frequently, the Treasury Bond is pegged to a 30-year loan payback. Other types of bonds investors buy are mortgage backed bonds, corporate bonds, or bonds issued by companies such as municipal bonds, or global bonds issued by other governments. All governments and corporations need bonds in order to borrow money. It’s commonly used for governments to fund roads, schools, bridges, dams, buildings, or other infrastructure. Here is an example to help grasp the concept of a bond: If the investor purchases a bond for $1,000; at the end of the one-year term the investor receives the $1,000 back, but also receives the interest along with it.
While it’s possible to buy individual bonds, many people choose to purchase them through bond mutual funds, which offer lower-cost access to a diversified group of bonds. The quality and safety of bonds help balance the risk associated with stock-based investments.
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