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The difference between stocks and bonds – a guide to initial investment

Investing is not as difficult as may many people may think. But there are many terms you need to learn before you start in this field. Stocks and bonds are common terms when it comes to the initial investment. Many people do not understand the differences between bonds and stocks – so we will unravel this mystery and give you the full information you need.

Shares buy ownership, bonds buy debt

For most of us, reaching the dream of early retirement involves investing the money we have raised over the years in order to increase it over time. Although there are many types of investments in different variants, stocks and bonds are two categories that are good to start with.

In simple words – through the shares ownership is acquired in various companies. This is also known as equity. When a company goes public (or puts its shares up for sale) such as Microsoft, Tesla, or Coca-Cola, they sell shares in their business publicly. By buying a stake in the company, it receives fresh money to upgrade its business, and in return, you receive part of the ownership in the company. If the company does well over time (like Google in recent years) and makes a profit, it increases the value of your shares. And if the business you’re investing in doesn’t do well, your stocks lose value, and in the worst case, you could lose them.

On the other side are the bonds

When you buy bonds, you are actually buying debt by borrowing money from the company or even the government. Instead of investing directly in the company, you give them money, and they agree to pay you for this interest. This interest is called a coupon and is paid over a period of time. The bonds also come with a maturity date – this is the date on which the issuer (the issuer of the bonds, respectively the company) must repay the amount of debt to its borrower. You can sell your bond before it matures. Depending on different aspects – you can sell this bond at a higher price or even lower than you bought it.

Because bonds are predictable in this way, they are called fixed-income securities. Let me give a specific example:

Let’s say you buy a $ 1,000 bond with an 8 percent coupon and 10 years to maturity. This means that you will receive $ 80 each year ($ 1,000 * 8%) until the due date. In fact, since most bonds pay interest every six months, you will receive two payments of $ 40 per year for 10 years. After the due date, the company will return your $ 1,000 that was originally invested.

Shares are considered more risky than bonds

When you buy shares, you can get a high return on investment if the company does well, which will mean that the shares increase in value. If you bought a share of Google back in 2004, then you paid $ 85 for it. 5 years later in 2010, the same stock was worth about $ 250. But if still keep this stock until this year, it will be valued at just over $ 2500, as of the time of writing this article, and you will make a profit of $ 2400. Great! But let me point out that most people don’t just buy one share from a company. So, if you bought 50 shares of Google in 2004 for $ 4250, those same shares are valued at just over $ 125,000 right now. You can see for yourself that stocks are a great way to increase your retirement savings.

Of course, there is always a risk, because, after all, not every company is like Google.

There are so many factors that could affect a company’s profitability, from incorporating new technologies into production, to consumer buying habits. For this reason, stocks are usually considered riskier investments, especially in the short term. In return for the risk, however, you can get a bigger reward.

S&P 500 Index

This is a financial index containing 500 of the largest companies in the United States. They may rise or fall over time, but for many years, these companies have performed quite well, making them quite a low risk when it comes to investing in the long run. Also, let me mention that investing all your money in a company, no matter how low-risk it may be, is quite bad and not recommended. Most experts recommend buying shares of different companies after a good analysis of their condition in recent financial periods.

As I mentioned earlier, bonds are considered a less risky investment than stocks. But they do not give much return on your investment. If you invest all your money in bonds, you will not get much profit from them in ten years period, for example.

The paradox is that the older you get, the more you would prefer to invest in bonds than in stocks. It’s time to take risks while you’re young, the older we get, the more we prefer safe action.

How much should we invest in stocks and bonds?

There are too many investment options beyond bonds and stocks. They are just a good start for any beginner with an interest in the field. So how much should you invest in each category? The answer depends on your age, your investment goals, risk tolerance, but here’s an interesting rule:

110 – your age = the percentage of your portfolio that you need to invest in stocks.

In my case, that percentage is 65. This means that if I have $ 10,000 to invest, I have to invest 6,500 of it in stocks.

As we grow up, these percentages need to be adjusted accordingly. If you follow rule 110, when you turn 40 you will want to buy more bonds than stocks. The closer you get to retirement, the more you will want to reduce your risk and you will want to invest in bonds. In other words, you don’t have much time to take risks.

Also, there are hundreds of tools online that allow you to calculate exactly how much to invest your money in stocks and bonds.

Every investment has a level of risk attached to it. The financial industry operates on a basic risk-reward principle: increased risk equals a greater chance of earning larger profits, and vice versa. As a result, stock investments come with some hazards that all investors should be aware of.

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