Deciding whether to invest in stocks or bonds can be confusing. People tell you that the stock and bond markets move in opposite directions, but what that means is not exactly clear. To make matters worse, the stock market is often referred to as the equity market and the bond market is the fixed income market, the debt market, the credit market or the capital market. Part of the bond market is also called the money market. It can all be very confusing.
When you buy stock, you are buying a percentage share of the underlying company, so if you own some shares of General Electric, you are a fractional owner of the General Electric company. Common stock represents ownership or equity in a company. The market prices of stocks fluctuate according to each company's financial performance and the outlook for its future performance.
When you buy a bond you are loaning money to the underlying company. Ownership of a bond puts you in the position of being a creditor. A bond pays a fixed interest payment every six months, which is why it is called a fixed income investment, and these credit instruments with short maturities under one year are called money market investments. Individual bond prices move according to the credit quality of the underlying company. If the company loses a lot of money and has trouble paying its bills, the bond market will require a higher interest rate return on investment, which means the bond price will decline.
When interest rates are low, companies can inexpensively borrow to finance their operations, so the general stock market rallies in expectation of increased corporate profits. When corporations are posting strong profits because the economy is strong, the stock market is high but the Federal Reserve generally chooses this time to start raising interest rates in order to cool the overheating economy. As interest rates in the bond market rise, the stock market generally declines because corporations have to pay more money to finance their operations and this cuts into their profitability. During times of crisis, the bond market rallies because of a flight to quality in which investors buy bonds to safeguard their principal. During crisis times, investors normally sell their stocks in order to invest in bonds, so the stock market declines.
If you are seeking safety for your money with a yearly income, the bond market is for you. Most investors in bonds do not trade their investments for profit. The stock market has the image of generating large profits for smart stock traders and tends to fluctuate more widely on a daily basis than the bond market.
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