Stocks and bonds are common types of investments that offer very different potential for risk and growth. Both are typically part of a balanced portfolio. Get comfortable with the risks and rewards before you dive in.
What are stocks?
Stocks are shares of ownership of a company. Stock transactions are conducted on stock exchanges. There are two types of stocks: Common stock and Preferred stock.
Common stockholders have voting rights and can attend the company's annual meetings, potentially influencing the company’s future direction. They sometimes receive dividends as part of the company’s earnings.
In contrast, preferred stocks do not have voting rights but are entitled to receive dividends before common stockholders.
The pros and cons of stocks are:
Pros:
1. Stocks have historically performed well
Though the stock market can go up and down in dramatic ways (presenting the risk of losing your investment), a selection of stocks in a balanced portfolio have historically grown faster and more reliably over the long term than less risky investments, like bonds and savings.
2. They’re easy to purchase
Brokers, financial planners and fintech services offer convenient ways to buy stocks on the stock market. Fees often vary widely, and it’s always important to buy stocks with guidance from trusted sources and in balance with your other investments.
3. You can access your funds easily
Stocks are highly liquid, meaning you can sell your stocks quickly to access your funds.
4. You can start with small amounts
You don't need huge amounts of money to buy stock. You can jumpstart with a small amount, with many services requiring only $5 or $10.
5. Stocks help you stay ahead of inflation
While inflation is reaching record highs now, it’s averaged around 3% annually over the past several decades. Stocks have historically performed better than that over the long term, helping you to avoid losing purchasing power.
Cons:
1. Exposure to high risk
If a company does poorly, investors may sell their shares, which could send the stock price down dramatically.
2. Stockholders are paid last
If a company goes broke, stockholders are often paid only after other debts are cleared. Among stockholders, the holders of preferred stocks are the first ones to be paid.
3. Requires research
Before buying stocks, you should research a company to determine its potential for growth. It's also important to monitor the stock market to see how it will affect the stock price.
4. The stock market can be volatile
Stocks have the potential to go up and down in a fast and sometimes unpredictable manner.
What are bonds?
Bonds pay a fixed rate of interest. It’s a type of loan you’re making to the borrower (usually governments or corporations) and is typically referred to as an I.O.U. between two parties that comes with a set of payment terms.
Bonds are usually used to finance projects and operations. Bondholders typically receive fixed interest payments at a set frequency, and bonds usually end (or “mature”) in one to three years, but can range up to 30 or even 100 years.
The pros and cons of bonds are:
Pros:
1. Fixed returns through regular interest payments
A bond gives you steady returns at fixed intervals. Take note of the “coupon rate.” It’s the amount you’ll receive either yearly or every six months for the duration of your investment.
2. Relatively less risky
With steady returns, bonds are considered one of the safest investment options compared to other types of investments. Bond issuers also have a legal obligation to pay holders first when the company goes into bankruptcy.
3. Bonds, like US Treasuries, can provide financial stability and liquidity
Bonds like U.S. Treasury bonds can be a steady source of income, involve less risk and remain much more liquid in the secondary bond markets, allowing you to sell before the end of the bond’s term.
Cons:
1. Lower long-term returns
Compared to the volatility of stocks, a bond’s fixed rate of return may look attractive. But the total returns can be lower.
2. Requires slightly larger sums
Many bonds fund large-scale projects, totalling millions of dollars. But U.S. Treasury bonds, for example, are often sold in $100 increments.
3. Companies can default
Even though bonds are more secure than stocks, a company in distress, failing to pay back its debts, can default on its bonds. In those cases, you’ll lose your principal investment as well as future payouts.
4. Interest rate fluctuations:
One critical factor when purchasing bonds is interest rate risk. When interest rates rise, your bond’s interest rate remains the same, locked in at a lower rate than you could get with other investments.
How can Bright help?
Bright can help you get started investing. With a personalized Bright Plan, we’ll study your income and spending habits, build a personalized budget, and move funds to make card payments for you.
Bright finds the fastest, smartest way to get you debt free while also building more savings. With the financial stability Bright provides, you can start to invest with confidence.
If you don't have it already, download the Bright app from the App Store or Google Play. Link your checking account and your cards, set a few goals and let Bright get to work!
