If you're starting out as an investor, you might be feeling overwhelmed. After all, it seems like there's just so much to know. How can you get enough of a handle on basic investment concepts so that you're comfortable in making well-informed choices?
Andrew Schlafer, financial advisor for Edward Jones says you can get a good grip on the investment process by becoming familiar with a few basic concepts. This morning, we'll look at "Stocks vs Bonds" and "Risk vs Reward".
When you buy stocks, or stock-based investments, you are buying ownership shares in companies. If you buy a company at an attractive or fair price, and the company increases it's profits, or earnings, the value of it's stock will generally increase in value over the long term.
By contrast, when you purchase bonds, you aren't becoming an "owner" — rather, you are lending money to a company or a governmental unit. Barring default, you can expect to receive regular interest payments for as long as you own your bond, and when it matures, you can expect to get your principal back.
Stocks move with demand, or lack their of, from investors. Generally speaking, it's a good idea to buy shares of quality companies and to hold these shares for the long term. This strategy may help you eventually overcome short-term price declines, which may affect all stocks. Keep in mind, though, that when buying stocks, there are no guarantees you won't lose some or all of your investment.
The liquidation value of bond prices do rise and fall, typically moving in the opposite direction of interest rates. So if you wanted to sell a bond before it matures, and interest rates have recently risen, you may have to offer your bond at a price lower than its face value.
For the most part, stocks are purchased for their growth potential, while bonds are bought for the income stream provided by interest payments. Ideally, though, it is important to build a diversified portfolio containing stocks, bonds, certificates of deposit (CDs), government securities and other investments designed to meet your goals and risk tolerances. Diversification is a strategy designed to help reduce the effects of market volatility on your portfolio; keep in mind, however, that diversification, by itself, can't guarantee a profit or protect against loss.
All investments carry some type of risk: Stocks and bonds can decline in value, while investments such as CDs can lose purchasing power over time. One important thing to keep in mind is that, generally, the greater the potential reward, the higher the risk.
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