When it comes to investing money most folks know that stock investing can be tricky business, although they don’t really understand it. Few know anything about bond investing, period. Here we shed some light on these two major investment options, and compare and contrast.
Money management basics: People get into stock investing to get growth (price appreciation) and maybe some income in the form of dividends. They get into bond investing primarily for the income bonds pay; because bonds pay more interest then they can get at the bank.
Money management rule #1 about stock investing: Stock prices fluctuate, which creates risk. Anyone investing money in a good (bull) stock market can make money. In a falling (bear) market virtually no average investors make money. Instead they lose it.
Money management rule #1 about bond investing: Bond prices fluctuate, which means that there is risk associated with bond investing as well. Bonds are safer than stocks because bond price fluctuations are not usually as severe, and bonds pay higher income (interest) than stocks do (dividends). But beware; you can lose money in bonds.
Now let’s take a closer look at investing money in these two investment options.
Scenario #1: Good financial and economic news turns to a steady barrage of bad news in the headlines. Stock prices plunge and continue to fall. Bond prices rise as investors sell stocks and buy bonds. This is called a flight to safety. Many investors use the investment strategy of investing in stocks AND bonds both to offset stock losses in a situation like this.
Scenario #2: Interest rates and inflation rise dramatically and keep going up.
Stock prices take a prolonged beating. Bond prices fall heavily as well. Investors are not making money in stocks or bonds. So much for our basic investment strategy of holding both of these investment options to offset risk … it doesn’t always work.
Stock investing is for folks who want growth and are willing to accept risk to get it. Bond investing is for those who want higher income when investing money, but who also understand the risks involved.
By investing money in both, your overall risk can be reduced … most of the time.
Smart investors know that in times of rising interest rates and/or inflation both investments can get hit hard. Stocks fall because corporate earnings take a hit. Bonds fall because of a thing called “interest rate risk”. Plus, because inflation makes the future value of a bond and its income stream less attractive, many investors sell them which sends prices down.
How do really smart investors avoid heavy losses in a truly bad economic scenario? They add two additional investment options to their investment portfolio: high quality money market securities for safety, and alternative investments for growth to offset other losses.
A retired financial planner, James Leitz has an MBA (finance) and 35 years of investing experience. For 20 years he advised individual investors, working directly with them helping them to reach their financial goals.
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