Many
companies offer investors the opportunity to buy either stocks
or bonds. The following example shows you how stocks and
bonds differ.
Let's say you believe that a company that makes automobiles
may be a good investment. Everyone you know is buying one
of their cars. Plus your friends report that the company's
cars run well for years and rarely break down. You either
have an investment professional investigate the company and
read as much as possible about it, or you do it your self.
After your research, you're convinced it's a solid company
that will sell many more cars in the years ahead.
The automobile company offers both stocks and bonds. With
the bonds, the company agrees to pay you back your initial
investment in ten years, plus pay you interest twice a year
at the rate of 8% a year.
If you buy the stock, you take on
the risk of potentially losing a portion or all of your
initial investment if the
company does poorly or the stock market does poorly. But
you may also see the stock increase in value beyond what
you could earn from the bonds. If you buy the stock, you
become an "owner" of the company. You'll only make
money if the company makes profits.
You wrestle with the decision. If you buy the bonds, you
will get your money back plus the 8% interest a year. And
you think the company will be able to honor its promise to
you on the bonds because it has been in business for many
years and doesn't look like it could go bankrupt.
Meanwhile, the company has a long history of making cars
and you know that its stock has gone up in price by 12% a
year, plus it typically paid stockholders a dividend of 4%
from its profits each year.
You take your time and make a careful decision. Only time
will tell if you made the right choice. You'll keep a close
eye on the company and keep the stock as long as the company
keeps selling a quality car that consumers want to drive.
Lois Center-Shabazz is the founder
of MsFinancialSavvy.com and author of the 3-time award-winning
personal finance book, Let's Get Financial Savvy! ISBN #0971979502.
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