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Stocks and Bonds: The Advantages and Disadvantages


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For a novice investor, the vast number of investment opportunities out there may understandably seem overwhelming. A good place to start in this situation would be to learn the numerous differences between two major types of securities: bonds and stocks. Both options have their pros and cons, so the better choice will vary from person to person, from place to place, or from year to year. Obviously, you’ll need to be familiar with what stocks and bonds are before you can examine their benefits and drawbacks.

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Stocks

Stocks are equity securities, which means that they represent partial ownership of corporate assets and allow for the collection of a portion of the company’s earnings [1]. When you purchase shares (unit of stock), that investment helps fund the corporation’s expansion or daily operations. The more stock you own, the more you stand to benefit when the company is making a profit [2]. If you don’t directly receive dividends of the profit, you can earn money by selling the shares when they are valued more than they were when you bought them [3]. This is the concept of capital gain.

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Bonds

Bonds, on the other hand, are debt securities, so they represent borrowed money that will be paid back before a certain date (called the maturity date) and with a predetermined interest rate [4]. You lend money to a company or government and will eventually receive that amount back plus interest [5]. There is no ownership involved here and the financial prosperity of the entity you are loaning to does not play a role in what you earn for the most part.

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Pros and Cons of Stocks

Stocks tend to produce much higher returns over extended periods of time, making them the smarter option for young investors aiming to gain large amounts of money [6]. Some stocks will also contain dividends that produce additional income for the investor [6]. However, nothing is guaranteed in the world of stocks. You can end up losing money by failing to sell your shares at a high enough price [6]. This is why careful decision-making is such a valuable skill when investing.

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Pros and Cons of Bonds

The prices of bonds do not fluctuate nearly as much as stocks [6], but they may go down a little when stocks are performing well [5] or when interest rates rise [6]. Income generated from bonds tends to be reliable and fixed, which makes them less risky than stocks and more suited for older investors reaching retirement [6]. Some bonds can both be liquidated and used for a steady income [6]. However, it must be noted once again that bonds will not perform as well over long stretches of time [6].

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Sources

  1. https://www.accountingtools.com/articles/equity-security

  2. https://www.investopedia.com/terms/s/stock.asp

  3. https://finance.zacks.com/make-money-stock-not-pay-dividend-3263.html

  4. https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/types-of-security/

  5. https://www.nerdwallet.com/article/investing/stocks-vs-bonds#:~:text=Stocks%20give%20you%20partial%20ownership,pay%20fixed%20interest%20over%20time.

  6. https://americanfundsretirement.retire.americanfunds.com/planning/what-is-asset-allocation/stocks-and-bonds.html#:~:text=Stocks%20offer%20an%20opportunity%20for,you're%20diversifying%20your%20portfolio.

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