Stocks and bonds are two types of investments. Both of these investments are bought and sold in markets in many countries. Investors purchase stocks and bonds to receive a return on their investment over time that is higher than alternative investments, such as savings accounts and certificates of deposit. Both stock and bond purchases involve risk, although stocks are usually more risky.
The reason stocks are riskier than many other investments is that they involve ownership in a public corporation. The price of the stock increases if investors believe the company will earn a profit in the future. If negative news comes out about a company, the stock price can drop rapidly as other investors sell off their stocks. According to the Securities and Exchange Commission, penny stocks, which are stocks with extremely low prices, are often difficult to sell and frequently become worthless.
Bonds are safer than stocks because they are a type of loan. The investor who purchases a bond is making a loan to a corporation or a government agency. The bond issuer makes payments on the bond until it is paid off. Some bonds provide a payment each period. Other bonds pay in full on a specific date. Fluctuations in the stock price or the value of the company do not affect the amount of money the bond pays out. Some bonds have higher priority for asset claims if a company goes bankrupt than others, so these bonds are even safer for cautious investors.
The main advantage of stocks is that they provide an unlimited potential for gain. An investor who purchases shares in a small company can sell these shares for a lot of money if the company grows much larger. Many stocks also provide dividends, which provide additional returns to investors. Historically, stocks have offered better returns over long periods of time than many other types of investments.
Because bonds are safer than stocks, they do not provide as much income to the investor. Mortgage bonds are backed by physical property, such as land, so they pay less interest than debenture bonds. With debenture bonds, the bond holder cannot repossess property if the bond issuer defaults, so debenture bonds pay more interest. The Code of Federal Regulations requires that some pension funds must purchase bonds secured by property, so these organisations receive a lower return on their investment over time.
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