Stocks and Bonds – And the winner is. . .
A: Thanks for joining us for Your Money.
B: Let’s say you have found a terrific company that makes a better mousetrap. You think that this mousetrap company will be a good investment. Everyone you know is buying its mousetraps.
A: Isn’t that “micetraps?”
B: I never can keep that straight. Anyhow, you’ve heard that the company’s products rarely break down and work well for years. So you investigate the company and read as much as possible about it.
A: After doing your research, you’re convinced it’s a solid company that will do really well in the years ahead. The company offers both stocks and bonds.
B: So you need to know – what is the difference between a stock and a bond?
A: When you buy a bond, you are loaning money to the company. The issuer of the bond promises to return your money, plus pay you interest.
B: If you buy stock, you become an “owner” of the company. That entitles you to part of the corporation's earnings and assets. Common stocks give shareholders voting rights but no guarantee of dividend payments. Preferred stocks provide no voting rights but usually guarantee a dividend payment.
A: So let’s go back to the mousetrap company. If you buy bonds, the mousetrap company agrees to pay you your money back in –let’s say - ten years, plus pay you interest twice a year at the rate of – let’s say - 8% a year. You’ll want to evaluate whether you think the company will be able to honor its promise to repay you, or whether it might go bankrupt.
B: If you buy stock in the mousetrap company, you take on the risk of potentially losing a portion or all of your initial investment if the company does poorly or the stock market drops in value. But you also may see the stock increase in value beyond what you could earn from the bonds, and it may pay dividends.
A: So which should you buy?
B: There is no “right” answer. You take your time and make a careful decision. Only time will tell if you made the right choice. You’ll keep a close eye on the company and keep the investment as long as the company keeps selling a quality mousetrap that customers want, and it can make an acceptable profit from its sales.
A: Let’s talk about how investments make you money. You get interest payments when you own a bond. Many – but not all – bonds pay a fixed rate of interest. Some bonds pay a variable interest rate. Either way, you’re getting interest payments.
B: With a stock, you own part of the company. If the company does well, it may make enough profits to pay you and the other stockholders dividend payments. Or, other people might recognize that it’s a good company so that the stock price goes up. When it comes time to sell your stock, you might be able to sell it for a profit.
A: But any investment can also lose money. Your investment can go down in value if the competitors are better than your company, so customers don’t want to buy the company’s products or services. Your investment can also do poorly if the company’s officers spend too much money, so that their expenses are higher than their profits.
B: And no matter how well the company performs in the long run, you can lose money if you have to sell when the market is down.
A: So that’s why smart people say that investing is for the long term – and why you never want to invest money that you will need in the near future.
B: That all said, I have one last question, do own more stocks or bonds?
A: Are those my only choices? Last time I checked, there were three major asset categories: stocks, bonds, and cash equivalents. Asset allocation is a very personal decision.
B. And a very important one, too. Some financial experts believe that how you divide your investment portfolio among different asset categories is the most important decision that you'll make with respect to your investments - that it's even more important than the individual investments you buy.
A. Sounds like a good topic for another podcast.
B. Definitely. Thanks for joining us. This podcast has been brought to you by the US Securities and Exchange Commission. Write us at email@example.com