Stocks and Bonds
Bonds are issued to raise money for cities, states, the federal government and corporations. Primary and secondary bond markets are essential parts of the capital-raising process. Private and public sectors use the money raised to do all sorts of things such as school improvements, building roads, opening new factories and buying the latest technology.
Bonds are bought and sold in huge quantities in the U.S. and around the world. There are some bonds that are easier to buy and sell than others, but that will not hinder investors from trading every type of bond, and it happens virtually every second of every trading day. In order to understand the process of buying and selling, it is helpful to understand the size and scope of the bond market, and why bonds are issued in the first place.
A bond is a loan that an investor makes to the government, a federal agency or other organization. Bonds are sometimes referred to as debt securities. Since the bond issuers know you aren't lending your money without compensation, the issuer of the bond (the borrower) enters into a legal agreement to pay you (the bondholder) interest.
The bond issuer agrees to repay the original sum loaned at the bond's maturity date, although there are various conditions (such as a bond being called) that may cause repayment to be made earlier. The vast majority of bonds have a set maturity date, which is a specific date when the bond must be paid back at its face value, also called its par value. Bonds are considered fixed-income securities because many pay you interest based on a predetermined interest rate or a coupon rate, which is set when the bond is issued. Following are some common terms that you can familiarize yourself with as you begin to understand the stocks and bonds market.
Blue Chip: This refers to a stock that comes from a company that is a high grade, high quality company or a major corporation, and they have a well established track record of paying dividends and increasing earnings. General Electric would be a good example of a Blue Chip company.
Defensive Stocks: These are stocks that come from companies that are more resistant to recession, such as utility companies.
Income Stocks: This is stock that pays a higher than average dividend. Investors who seek consistent income that is higher than average would buy income stocks.
Growth Market: This signifies a time when shares, earnings and sales are expanding at a rate faster than average. Dividends are usually small because earnings are being reinvested back into the company for growth. Many technology companies are growth stocks.
Seasonal Earnings: This is when the earnings fluctuate with the calendar and changing seasons. Retail stores are often seasonal.
Cyclical Businesses: The automobile manufacturing and steel manufacturing business are cyclical, because their earnings and stock prices tend to fluctuate with the business cycles. This is not the same as seasonal due to the fact that the business cycle is not always in a one year cycle.
Stocks or Bonds
If you are not sure what you should invest in, remember the main thing to consider is the risk versus the potential of both stocks and bonds. Stocks have much greater potential to increase in value but they are also more subject to market fluctuations. Bonds that are considered investment grade bonds, or those with a rating of BBB or better, will carry less risk but they also will offer a relatively low yield.
An investor who has done his homework would usually choose bonds for the short term. They offer greater security and return in the short term, but the situation changes if you are looking at a long term investment, a span of ten years or longer. Over the long haul, the investor will find that the stock market has consistently outperformed bond investments by a large factor. This is due to the fact that well established companies will continue to increase in value. The short term fluctuations in the stock market are smoothed out over time.
There is still a place in the investor’s portfolio for bonds though. They provide a stable investment that helps cushion against stock market fluctuation. The best advice is to have a mixture of investments, which include stocks from various industries, bonds and other fixed-income investments. This way you will be provided a maximum growth while securing your investment funds for the future.