Stocks and bonds are two key investing tools that can grow your money to help you reach your financial goals, but it’s important to understand the basics first. Knowing how to invest means understanding the difference between stocks and bonds and how they affect the performance of your overall investment portfolio. Here’s a quick look at the difference between stocks and bonds, plus information on the different types of bonds, how to buy stocks, how to buy bonds and how to determine the best investments for you. Understand the differences to help you choose the best investments if you’re a beginner investor.
What Are Stocks?
Stocks represent ownership shares in a company. When you buy 100 shares of Facebook stock, for example, you actually own part of the company. Facebook has about 2.89 billion shares outstanding, so your 100 shares don’t represent a large ownership portion; however, you would still participate in the same percentage gain or loss per share as Mark Zuckerberg himself.
What Are Bonds?
A bond represents a loan you make as an investor to a company in exchange for interest paid on the bond until maturity when the company pays back the principal. Different types of bonds are available, ranging from Treasury bonds issued by the U.S. government — considered among the safest types of bonds — to corporate bonds issued by individual corporations. Like stocks, bond prices can fluctuate based on various factors.
How to Buy Stocks and Bonds
To buy stocks or bonds, you’ll typically need an account at a brokerage firm. Different types of brokers exist to help with a range of investor needs. If you require investment advice, you might be interested in a full-service firm, which provides research reports, customized financial advice and other services, all for a fee. Discount brokers charge lower prices for buying and selling stocks or bonds, but have a commensurate reduction in offered services.
To place orders, you can call your broker, enter a trade online or use a mobile device. Some companies also allow you to buy stocks directly, without the use of a broker.
One way many corporate employees buy stock is through an employee stock option plan. Stock options give you the right, but not the obligation, to buy shares of stock at a certain price during a certain period of time.
Bonds vs. Stocks
Investing in bonds is often considered a more conservative option than investing in stocks; however, bonds do carry risk as well. Bond risks include interest rate risk, in which rising interest rates reduce the market value of the bond, and credit risk, which is the risk that a company won’t be able to pay you interest or principal. A bond investor typically seeks income and security. A bond yield tells an investor what type of return to expect.
Yields can be measured in a number of ways, including:
- Coupon yield: the stated interest rate the bond pays
- Current yield: the stated interest rate divided by the bond’s price
- Yield to maturity: the total rate of return if an investor holds a bond to maturity
- Yield to call: the total rate of return if the bond is called away at a date before maturity
- Yield to worst: equal to the lower return of either yield to maturity or yield to call
Stock investors generally seek growth of capital, known as capital gains, rather than income. Some stocks pay a dividend, which is a cash payment of company earnings to shareholders. However, many stocks, even well-known ones like Amazon and Facebook, don’t pay a dividend.
Related: 6 Best Long-Term Investments
The Best Investment for You
Before you dive into investing, you should consider some factors and your financial strategy so you can choose the right investments for yourself. Here are a number of different variables to consider before choosing your investments:
- Your age
- Your financial situation, including net worth and annual income
- Your time horizon, or how long you intend to invest
- Your financial goals
- Your ability to tolerate risk or price fluctuations of investments
- Your investment experience
- Your tax rate
- Other investments you might already hold, including those in retirement accounts like a 401k
Understanding the differences between stocks and bonds and your unique variables and goals will help you to choose the best investments for your investment portfolio.