Stocks and bonds are two of the most common investment options. Today, we’re going to delve into what they are, their advantages and disadvantages, and the best time to invest in each one. So let’s get started:
1. What are Shares?
A share is the unit of partial ownership and a shareholder is someone who has invested in a particular company by buying shares. A publicly-traded company is one whose stock shares are bought and sold on a public stock exchange.
Of course, privately-owned companies have shares too, even if they’re not traded on the stock exchange. These shares are held by partners who are partial owners of the company and can’t be publicly bought and sold, but they can be bought and sold with special agreements between all the parties in the transaction.
2. What are Bonds?
Bonds are essentially loan certificates. The investor lends a certain amount to a company and is given a bond in exchange, listing the transaction details including who owes who, how much was lent, and how much is to be paid when the loan period ends.
There are two primary bond categories: those issued by publicly-traded companies, known as corporate bonds, and bonds issued by the government, known simply as government bonds.
3. What are the Pros and Cons of Stock Shares?
By definition, a stock’s value is a percentage of the company’s value. When a company’s value goes up, the value of a single share of the stock goes up with it and the rise in price can be dramatic.
However, this is also a disadvantage. If the company’s value drops, whether suddenly or gradually, the stock’s value will also drop.
In the most extreme case, when a company goes bankrupt, shareholders can expect to be the last to get their money back. In the best case scenario, they will get some partial payment only after employees and creditors have been paid.
4. What are the Pros and Cons of Bonds?
In essence, a bond is a loan that an investor gives a company. Businesses or governments can issue series of bonds that last for varying amounts of time (1-30 years) and will be paid back with interest. The principal loan is usually paid back at the end of the period while the interest is either also paid then or paid more frequently (e.g. quarterly).
This makes their reliability the most important advantage of bonds. They are also relatively safe investment options, particularly bonds issued by the government or large corporations. Of course, you pay for peace-of-mind with lower yields. The more solid the investment, the more moderate the returns are likely to be. US government bonds, considered the benchmark for the global bond market, are among the world’s safest investments and therefore offer a very low interest rate, as you might expect for any low-risk investment. “Junk bonds”, on the other hand, are bonds issued by companies that are on bad financial footing, and therefore offer unusually high risk and unusually high returns.
The primary disadvantage depends on the type of bond: government bonds and other solid bonds only offer moderate yields, while there is a danger of losing money with higher-yield bonds. However, it is important to remember that even in the extreme case of a company being dissolved, bondholders will get their money back before shareholders.
5. How Do Stocks and Bonds Fit into the Optimal Investment Portfolio?
Diversification is a key element in the creation of an optimized portfolio, on a number of aspects, including the types of stocks. Stock shares offer partial ownership of the company, whereas bonds are loans to the company and relatively lower-risk (at least officially). Bonds, of varying risk and yield levels, combined with stock shares, which also have a range of risk levels, allow you to safely diversify your portfolio.
Stocks are less restricted and more dynamic than ETFs and bonds. They tend to offer greater rewards, alongside bigger risks. Cherries applies the scientific principles of MPT to the stocks alone, making sure that this relatively risky area of your portfolio is made safe. Cherries optimized portfolios include a diverse range of stocks from the three major US stock exchanges. You can learn more here about the composition of Cherries portfolios.