If you’re a relatively new investor, you may be wondering what types of investments you should be looking to put your money in. While there are plenty of different ways to buy them, it’s likely the actual investments you make will be in one of two basic categories: bonds or stocks.
For some, figuring out what exactly these two investment types are can be a bit intimidating. This guide will explain the differences between bonds vs. stocks and also take you through how to purchase both stocks and bonds. While this article will shed some light on which investment may make the most sense for you, you might also consider finding a financial advisor to work with through SmartAsset’s free financial advisor matching tool.
What Are Stocks?
When you buy stock, what you’re buying is a tiny piece of a company. If, for instance, you buy stock from Tesla, you own a small piece of Elon Musk’s electric car company. Companies sell stock in order to raise money. When a company that was originally privately owned goes to the market and sells stock, that is called an initial public offering (IPO). When big or popular companies offer an IPO, it is generally a big news story.
You can buy and sell stocks through a stock market. Most stocks in the United States are listed on either the New York Stock Exchange (NYSE) or the Nasdaq. The market determines the price. Generally, investors like to buy a stock when the price is relatively low and sell it when the price is relatively high. This allows them to make money from their investment.
What Are Bonds?
A bond is a certificate of debt. Essentially, you are lending money to whatever entity is issuing the bond. When you buy a bond, you’ll be able to see the price, the time to maturity and the coupon rate. The coupon rate is the money you’ll eventually get. It is generally shown as a percentage of the principal you spent on the bond.
There are a number of different types of bonds. One is a treasury bond. This is a bond from the United States government. You can also buy a municipal bond, which is issued by a local government, or a corporate bond, which is issued by a company.
Another type of bond you may have heard of is a mortgage bond, also called a mortgage-backed security. These are bonds backed by real estate mortgages and are the product that caused such a stir during the 2008 financial crisis.
Bonds vs. Stocks: Which Should You Buy?
The choice of whether to invest in stocks or bonds is a personal one, and there is no simple answer. However, there are some basic guidelines that can help you make decide which is going to be the best option for you.
Generally speaking, stocks are riskier than bonds. The prices of stocks can vary widely, and you never know what could cause a major fluctuation in the market. You could invest in a company that is on the road to big success only to find out there is a major flaw in its business plan and see the stock price tumble. Or, there could be some political event that causes the whole stock market to fall drastically.
On the other hand, a well-timed stock market purchase or a stock purchase that is held for a long period of time could end up resulting in a big return on investment for you.
Bonds, meanwhile, tend to be safer. If a bond has a high rating, it is very likely to give you the promised return. That return is not going to be as big, though, as a more risky investment like a stock.
If you’re a younger investor who is further from retirement, you might be open to taking a few more risks and investing in some stocks. If you’re older and are just trying to pad your account as you head into your golden years, bonds may be the better choice. For most people, building a mixed portfolio made of some stocks and some bonds is likely the best course of action, taking care to taper towards a more bond-heavy mix as you get older.
How to Buy Stocks and Bonds
To buy an individual stock, you can go through a stockbroker, either a human stockbroker or an electronic brokerage. To buy a treasury bond, you can go directly through the U.S. Treasury. You can purchase other types of bonds similarly to how you purchase stocks, through a broker.
Another way to buy stocks and bonds is by purchasing mutual funds or exchange-traded funds. Both of these types of funds invest your money in a bundle of investments, creating a diversified portfolio. The investments will either be chosen by a fund manager (active management) or will track an established index like the S&P 500 (passive management).
The Bottom Line
Stocks and bonds are two of the most important building blocks for any investor. While stocks are riskier, bonds offer less of a chance for a big return on investment. Most people will want to allocate their assets among both types of investments, as well as others, to create a balanced mix.
- If you’re starting to think about investing and aren’t sure where to start, consider working with a financial advisor. Finding the right one, though, isn’t easy. SmartAsset can help with our financial advisor matching service. First you’ll answer a series of questions about your financial situation and goals. Our program will then match you with up to three financial advisors in your area. We have fully vetted all of the advisors on our platform and ensured they don’t have any relevant disclosures. Each of your advisor matches will then reach out to you to talk about working together.
- If you’re wondering how to split up your investments, SmartAsset offers a free asset allocation calculator. This can help you figure out how you want to spread out your assets among various investment types.
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