Stocks and bonds offer families a range of opportunities to invest their money to boost their income or provide for a comfortable retirement. Stock and bond markets can, however, be challenging to understand for the beginner, and all investors face the risk of their investments losing value rather than growing. Investing in stocks and bonds should only be done after careful study or with the assistance of a professional.
Stocks represent shares of ownership corporations. Rather than being owned by an individual or group of partners, corporations are owned collectively by their stockholders, who have the right to vote on the board of directors and approve major company decisions. You can purchase stocks with the intent of selling them at a profit or holding them to collect dividend income. You can choose to hold a stock for a short period of time before selling it to take advantage of quick upward price shifts, or you can hold the stock for a longer term while its value slowly accumulates.
Bonds are essentially written promises to repay loans in a specific way. Corporations and government entities issue bonds to investors in return for quick capital. The bond issuer then pays interest annually to the investor over the life of the bond, repaying the principal amount at the end of the bond term. As with stocks, you can choose to hold bonds to maturity, collecting interest income annually or you may choose to trade bonds on the bond market for quick profits.
Risk tolerance refers to your family's unique preference for the balance between safety and profit potential. Younger households are generally encouraged to take on a higher risk tolerance, investing more heavily in fast-growth stocks and trading bonds, since they have a longer investment time horizon than older families. Households with a lower risk tolerance, on the other hand, should favor dividend stocks or holding bonds to maturity. There is still the risk of default on bonds and altered dividend policies on stocks, but the risks are generally lower than other options.
Mutual funds offer investors a hands-off approach to playing the stock and bond markets. Fund managers pool capital from a large number of investors, then invest the money in various bundles of stocks and bonds, referred to as funds. Mutual funds offer the security of trusting your money to a seasoned professional, but investors still face the possibility of losing money in the fund.
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