Beginners Guide to Investments in Stocks & Bonds
- Governments and companies raise money needed for operations by selling bonds. Bonds are debt securities. Because bonds represent the loans of a corporation, these obligations are senior to the company's equity issues or stock. Bondholders must receive timely payment of interest and repayment of principal when the bond loan matures.
U.S. Treasury bonds are considered the safest bonds for investors to own to maturity. Treasury bonds provide ready liquidity when investors wish to convert their bonds back to cash before maturity. However, because interest rates directly affect bond prices, rising interest rates may mean a loss of principal. - The bonds of corporations usually pay higher coupons, or interest rates, than government bonds. Corporate bond loans represent more investment risk than U.S. Treasury bonds. Corporations are affected by the general economy as well as business demand for their goods and services. Additionally, coupon interest from corporate bond loans is taxable to investors. For that reason, some investors purchase high-quality corporate bonds for their tax-deferred retirement plans.
- U.S. Treasury bond interest is exempt from state and local taxes: only federal taxes are due on coupon interest payments. Some U.S. savings bonds may yield entirely tax-free interest when used to pay for higher education tuition. Municipal bonds, or the loans of state and local governments, are considered tax-free investments to bondholder residents.
Build America Bonds (BAB), a type of municipal bond that funds state and local renewal projects, pay higher interest than other municipal bonds. Their interest is taxable to investors. Some BABs have paid higher interest than mid-investment grade level corporate bonds in 2010, according to Barron's. - Companies also raise money by selling equity, or ownership. Governments do not sell stock.
Companies sell stock through public markets. Equity raised by the company is not a loan. Money raised through an equity issue is considered capital of the company. Management may use this money to run the company. The owner of each share of stock owns a small piece of the company. Stockholders receive a share of profits, if any. They also have voting rights regarding the company's management. Their voting power increases with the amount of stock owned.
Stock investments are riskier than bond investments held to maturity. - A company may decide to use all of its profits to increase business. A company is not required to pay dividends to investors. However, many large and financially sound companies pay quarterly dividends to their investor-owners. Most investors like receiving dividend payments. Dividend payments increase total portfolio income.