What’s the Difference Between Stocks and Bonds?

What’s the Difference Between Stocks and Bonds?

There are two dominant asset classes: stocks and bonds. Sure, international stocks, real estate, and commodities also have a part in most peoples’ portfolios, but you really only need the two mentioned above to unprotected to a minimum level of diversification. consequently, the stocks vs bonds question is an important one for investors. It is also important to understand why you need both. Proper risk management demands you own at the minimum some of both asset classes: stocks and bonds. However, the amount of each you own will depend largely on your risk tolerance and time horizon. Young investors will want to own more stocks and older investors more bonds.

So, what’s the difference?

Bonds, no the other hand, are basically a loan, exactly the same as if you borrowed money to buy a home or a car. When you buy bonds you have a legal right to receive a stated rate of interest in return. This contractual right comes before the rights of shared shareholders; however, bonds generally do not allow you to participate in the decision making of the company. They also usually do not increase in value if the company grows its profits. They are far less risky than stocks, however.

Both stocks and bonds are issued by a company to raise capital. Stocks represent an actual equity investment in the company; an actual ownership stake in that company. When you own stock in a company you own the right to vote for board members, on important policy decisions, and most importantly, the right to a proportion of any residual profits that may exist after the bills have been paid. If the company in question manages to increase its profits, the value of the stock will rise steadily over time along with earnings. And if the company sees fit to pay a dividend, stock ownership makes you eligible to receive a cut of the profits.

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