When you invest in debt, you buy bonds, Treasury notes or Treasury bills. This is debt investing, because you loan money to the organization issuing the investment. In return, you earn interest for a set period. When you buy stocks, you hold an equity investment. You own part of the company, or as investors say, you have equity. That gives you the right to share profits. Choose debt or equity based on your goals.
Debt Investing Advantages
Bonds tend to be safer than stocks, with bonds, notes and bills issued by the federal government considered very safe. Even though the United States theoretically could default on its interest payments, this has never happened. Corporate bonds offer less safety but higher interest payments. Corporations have defaulted on bond payments, but this is such a devastating blow for a company's credit rating and status with investors that the vast majority of corporations avoid default at all costs. Your bond provides you with a steady and predictable income for the life of the bond. Bonds sometimes increase in value because interest rates drop below the interest you being paid on your bond. This means investors will pay a premium for your bond. In that case, you can sell the bond for more than you paid for it.
Debt Investing Disadvantages
Getting stuck with a bond that pays low interest is a downside of debt investing. For example, if you buy a bond that matures in 10 years and pays 4 percent interest, you're at a disadvantage if rates rise to the point that new bonds pay 5 percent interest. Investors won't find your bond attractive. If you want to sell it, you will have to offer a discount and sell it for less than you bought it for. Bonds provide income but little or no growth. Equities tend to outperform bonds in terms of growth.
Equity Investing Advantages
Stocks can increase the value of your portfolio. Since 1950, the Standard and Poor's 500 stock market index has grown an average of 16.7 percent a year, according to Yahoo Finance. In addition, some stocks pay dividends. If you reinvest those dividends, you can grow your portfolio even faster than if you took the dividends as income.
Equity Investing Disadvantages
Stocks have problems of their own, as they can lose value quickly. A bad profit report from a company can cause its stock price to drop. A downturn in the economy can drive stock prices down as well. Individual stocks can even fluctuate when the stock market as a whole is climbing. Poor timing -- holding onto stock too long, panicked selling at a loss or buying when the stock is overpriced -- can devastate a portfolio.
- PhotoObjects.net/PhotoObjects.net/Getty Images
- How to Get a No-Gimmick Loan
- How to Achieve Credit Repair
- What Can You Do if Your Mortgage Company Will Not Work With You?
- Two Life Changes That May Require You to Update Your Financial Plan
- Credit Union Insurance Explained
- How Is the Length of a Loan Determined on a Car Loan?
- What to Ask About Refinancing
- Can I Charge the Balance of a Credit Card to Another One to Lower My Interest?
- How to Repair a Credit Error
- Auto Financing With High FICO Scores