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Financial
Focus
Provided by Michael J Haynes
Edward Jones Investments
Learn
the "Basics'' of Stocks and
Bonds
If you're
fairly new at investing, you might find it
to be somewhat confusing. What are the
benefits of stocks and bonds? What are the
risks? Is there a good reason to invest in
both?
Once you
know the answers to these questions,
you'll have a good understanding of
investment "basics'' - and that knowledge
can serve you well.
So, let's
begin with stocks. What are they and why
do people invest in them? Simply put,
stocks represent ownership shares in a
company. When you buy stock in Company
ABC, you own a piece of it, however small.
You'll receive ABC's annual report, and
typically you are entitled to vote on some
important company issues, such as whether
to issue additional stock or replace ABC's
board of directors.
People
invest in stocks because they hope to
profit by selling their shares for more
than what they paid. The stocks most
likely to provide these profits are
usually called "growth'' stocks. But
investors also purchase stocks for the
"income" they can receive as dividends,
which are paid from the company's profits.
These stocks offer both the potential for
growth and the oportunity to receive
dividends and are typically called "growth
and income" stocks.
When you
buy stocks, you assume certain risks, such
as the possible loss of principal. As a
(very) general rule, the greater a stock's
potential for growth, the greater the
investment risk.
Now, let's
switch from stocks to bonds. When you buy
a bond, you don't own anything - you're
just making a loan. You can buy bonds
issued by companies (corporate bonds), the
government (Treasury bonds) or cities and
states (municipal bonds). In each case,
you are loaning out your money in exchange
for regular interest payments and the
return of the bond's face value when the
bond matures.
Bonds,
like stocks, carry risks. If you buy a
corporate bond from a company that runs
into problems, the company may default on
your bond, and you won't get your
principal back. Generally, you can help to
avoid this problem by investing in
high-quality bonds. Municipalities can
also get into trouble and default. U.S.
government bonds, though, are considered
to be the safest investment in the world,
at least in regard to default
potential.
When you
invest in bonds, you'll also take on other
risks. For one thing, if your bond matures
at a time when rates have fallen, you may
have to reinvest the proceeds in a bond
that pays a lower interest rate. On the
other hand, when interest rates rise, the
value of your existing bonds will fall.
Let's look at the following example: With
all things being equal, your bond pays
four percent, and market rates rise to six
percent, no one will want to pay you the
full price for your bond. So, if you want
to sell it, you'll have to offer it at a
discount. By holding your bonds until
maturity, though, you won't have to worry
about price fluctuations.
Stocks and
bonds clearly have some different benefits
and different risks. And stocks and bonds
frequently move in different directions.
When the stock market is slumping, bonds
sometimes perform well - and vice versa.
That's why you'll want to build a
diversified portfolio by investing in a
variety of stocks and bonds. By spreading
your dollars this way, you can help
cushion your portfolio from downturns that
hit one type of asset particularly hard -
and you can give yourself more chances to
succeed.
It's true
that the investment world can get pretty
complex. But it all starts with the
basics: stocks and bonds. Try to become
familiar with both of them - it will be
time well spent.
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