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Difference between Stocks and Bonds

We all know that the problem is not the money but how to spend it. In an investorís case, the problem is how to invest it. For the new investor, watching going through an investment newsletter can be a daunting task. Trying to figure out the difference between stocks and bonds from all the financial jargon can be a headache.

Stocks in their simplest form represent part ownership in a company. For example if you own 10 shares in a company that has 100 shares, you will own 10% of the company. If the company is doing well, so are you. If it is doing poorly, so are you. Companies have realized that it is cheaper to raise funds for their activities by offering part ownership in their companies.

Bonds on the other hand are a loan that you give to a company. The company or government will pay you interest for using your money for their activities. For example, if you bought a bond for 100 pounds with an interest rate of 5% over 5 years. The company owes you the interest plus the 100 pounds.

A company must pay back any funds that accrue to a bondholder. However, the shareholder (owner of stock), does not have to be paid anything. The shareholder is taking a risk that the company will do well and even in bad times, he will continue holding the stock in the hope that things will get better. The bondholder on the other hand does not care about the bad or good times in a company; he only wants his investment paid back plus the interest.

When deciding whether to invest in shares in a company or bonds, you should note that bond returns are fixed while the returns on shares can fluctuate and are not guaranteed. You should also note that in case a company winds down or is bankrupt, the bondholders are paid first and the shareholders last.

A good investment portfolio contains both stocks and bonds. If you are investor only interested in short term returns, then you should have more bonds than stocks in your investment portfolio. Bonds will provide you with a consistent income and in cases of market fluctuations, they offer a great cushion.

However, if you are planning on investing your funds for longer than 10 years, then your investment portfolio should have more stocks as companies will tend to increase in value in the long term.

As a rule of thumb, the younger you are, the more you should invest in stocks than bonds in your investment portfolio. Most investment managers recommend 70% stocks and 30% in bonds for anyone under 30 years. The older you get, the lower the percentage of stocks you should hold, as you are more interested in income than growth in your portfolio. Discuss these issues with your investment advisor and you are likely to do very well in the stock market.