What is the difference between stocks and bonds? If you’ve just learned how to invest, it can be confusing. Here is an explanation
If you want to build wealth , especially in the long term, investing in the stock market is a necessity.
But why ? Couldn’t you invest in real estate, precious metals like silver and gold , or even a new kind of investment like cryptocurrencies to achieve your financial goals? If you could, you’d be missing out on one of the greatest (if not the best) wealth creators of all time.
If you’ve never invested in the stock market, you probably have no idea where to start. You may not even know what an investment really is. One of the most common questions for beginners is ‘What should I invest in?’
Two of the most common types of investment are stocks and bonds. This article explains what stocks and bonds are, the differences between them, the benefits of holding them in a portfolio, and where you can buy them.
But before getting into the details of stocks and bonds, I think it would be a good idea to show why the stock market is such a great builder of wealth.
1. Why the stock market makes it possible to accumulate fortunes
The stock market helps people build wealth through the power of composition. Most people, whether they are investors or not, are familiar with this term. Simply put, compounding is the multiplication of past growth. When you earn $20 in a savings account, for example, those $20 earnings increase (or “compound”) in the future. It’s a virtuous cycle!
If you haven’t seen how market capitalization affects long-term wealth, you may not understand why investing in the stock market is so necessary.
Here is an example :
Let’s say we have two different people, savers A and B. Both are 35 years old, have $10,000 to invest, and plan to retire at 65.
Investor A wants to invest in the stock market, so he decides to invest in a portfolio of stocks and bonds with an average return of 6.8% per year.
Investor B is not interested in the stock market. In fact, he is rather afraid of it. So he decides to put his money in a high-yield savings account earning 1.8% per year.
Let’s see what difference it makes:
Economizer A: 20,400 Euros
Saver B: €5,400
Capitalization makes a big difference!
Saver A has multiplied his investment by more than seven! Saver B, on the other hand, has not even doubled his investment. Now imagine adding more to your stack every year and you’ll realize that investing in the stock market regularly makes a huge difference compared to investing in a savings account – or, even worse, not investing at all. .
2. What do actions mean?
Buying shares is like acquiring a very small piece of ownership in a company.
When a company issues public shares for the first time, it decides how many shares to issue. These are called actions. For example, a company may issue 100,000 shares that investors can buy. Each share is considered a fraction of the ownership of the company.
When you buy one of these shares, you own a tangible part of the company. This is commonly referred to as social capital. As a shareholder, you enjoy benefits such as the right to vote within the company, as well as a right to the profits and assets of the company.
However, the biggest benefit is seeing the value of your shares increase over time and sharing in the profits of the company. The two primary ways stocks create wealth are capital appreciation and dividends.
We talk about capital appreciation when the price of a stock is worth more than when you bought it. For example, if you buy an Apple share at 150 euros and then sell it at 300 euros, this is a capital gain of 150 euros.
This is the primary way that stocks contribute to building wealth. Stocks typically show an average growth of 6.8% per year. (But, it is important to note that the average is not the normal. And in some years stocks lose money).
Dividends are amounts paid to shareholders, often quarterly, in exchange for their stake in the company. (Not all companies pay dividends.) Dividends are paid for every stock you own.
For example, if you own 100 shares of Company X and its dividend per share is $0.02, you will earn $2 in dividends. This income is a secondary way for stocks to build wealth.
3. What do bonds mean?
Bonds, on the other hand, 👉 are securities issued by the federal government,👉 local government, bank, or other entity. Essentially, when you buy a bond, you are lending the bond issuer money. In exchange, the entity promises to repay you the full amount of the loan, plus interest while you hold it, in exchange for lending the money.
Bonds earn money in two ways: interest and capital appreciation.
Since the purpose of a bond is to provide regular income with less volatility, interest is paid more frequently, usually twice a year, but depending on the bond and type, it may even be issued monthly. These interest rates can vary widely depending on the type of bond and when it is issued.
Compared to stocks, the capital appreciation of a bond is much lower. While stocks gain an average of 6.8% appreciation per year, a bond may only appreciate 2.4% per year.
4. How are stocks and bonds different?
Although stocks and bonds are similar in many ways, there are a number of differences between these two asset classes. The main differences between them are their purpose in your portfolio, the risk associated with each, their performance, volatility and liquidity.
Stocks are supposed to provide the best return for your portfolio. As they have a higher potential for loss, stocks are considered riskier. This higher risk corresponds to greater price fluctuations in the market, which means that they are much more volatile than bonds.
Conversely, the purpose of a bond is to provide stability and income to your portfolio. Because their potential for loss is lower than that of stocks, bonds are considered relatively low risk. This lower risk translates into greater stability, meaning they are less volatile than bonds.
The performance of stocks and bonds also varies widely. While the stock market shows an average return of around 6.8% per year, adjusted for inflation, the bond market only shows an average return of 2.4% per year.
Having both in your portfolio allows you to benefit from the increased exposure to the return potential of equities while mitigating their risk through bonds.
Stocks and bonds also differ in their degree of liquidity. A stock can be sold relatively quickly, any time the market is open.
A bond can be sold in different ways, but if the bond has not yet matured, you may not get back the face value of your bond.
5. The benefits of stocks and bonds in a portfolio
Depending on your financial goals, you can invest more in stocks or bonds. Most wallets use a combination of the two. Indeed, the performance of equities and bonds on the market complement each other.
For example, when the stock market is doing well, bonds tend to stay flat or fall in value. When the stock market is doing poorly, investors typically turn to bonds, which rise in value.
The combination of stocks and bonds in your portfolio helps diversify your portfolio and minimize risk.
Asset allocation is how your portfolio is structured. It is usually described in terms of the proportion of stocks to bonds in your portfolio. For example, if your portfolio is 80/20, that means your portfolio is eighty percent stocks and twenty percent bonds.
Your asset allocation will depend on many factors, including your age, income, risk tolerance, distance to retirement, and more. If you are just starting to invest, you can opt for a 60/40 split. This distribution is considered to be quite conservative. It is a safe starting point.
Another rule 👉 of thumb you can use to get your asset allocation is to subtract your age from 100. The result is the percentage of your portfolio you should have in stocks.
For example, if you are 30 years old, you should keep 70% of your portfolio in stocks. If you’re 70, you should only keep 30% of your portfolio in stocks. While these rules of thumb are helpful starting points, it’s best to have a plan for your asset allocation and stick to it.
6. Where to buy stocks and bonds?
Although stocks and bonds are different types of assets, they can usually be purchased in the same place.
You can buy stocks and bonds using a number of different services, 👉 including brokerage firms, financial advisors, 👉 and mobile apps.
A brokerage firm 👉 also called a broker 👉 is a financial institution that allows you to buy and sell securities. 👉 Whether it’s stocks, bonds, mutual funds, ETFs or REITs, most people use brokerage firms to invest.
A brokerage firm usually offers additional features to help investors, such as advanced trading tools, educational materials, videos, webinars, etc.
Here are some of the most well-known brokerage firms:
A brokerage firm works great 👀 if you know what you want to invest in and are comfortable managing your portfolio yourself.
A financial advisor is an umbrella term for anyone who helps you manage your assets, but not all financial advisors are the same.
Some financial advisors can develop a plan to help you build wealth , minimize debt , save for a specific goal, and advise you for the long term. Others may simply execute transactions on your behalf.
The type of financial advisor you need will largely depend on your financial goals. Another important thing to keep in mind is that financial advisors charge fees. These fees can vary between 0.25% and 1% of the value of your portfolio, depending on the type of advisor.
When investing, it’s important to minimize fees, as they can eat up a large portion of your gains. Still, some people choose to use a financial advisor because they believe it gives them better returns, even after fees.👉 In many cases, however,👉 this is not the case.
Thanks to the ubiquity of the mobile phone, you can now buy stocks and bonds on the go using apps on your smartphone.
Some of these apps, like Bux Zero, allow you to buy individual stocks. Others, like DEGIRO, allow investing by buying mutual funds and ETFs.
Mobile apps are generally among the easiest platforms to use for investing because they don’t charge high fees and the cost of minimum balance is low.
Here are some of the most popular mobile apps today:
- Bux Zero
Investing in a portfolio of stocks and bonds (divided according to your risk tolerance) is one of the best ways to
build long-term wealth . It is also one of the main tools that I (like many other people) use to become financially independent.Whatever your financial goals, investing in stocks and bonds is one of the smartest, fastest and easiest ways to get there.Maybe you can even retire early!Moreover, with today’s technology, the barrier to entry of investing is so low that it is accessible to virtually anyone with a cell phone. If you’re ready to take control of your financial life to build the life of your dreams, invest in stocks and bonds. You can do this for as little as $5 to start.