Before Investing in Stocks & Bonds

8-½ minutes to read.

Stocks and bonds are two of the most common financial instruments for investing. Depending on your objectives, either or both may be right for you. Knowing these basics will allow you to communicate clearly with financial professionals and make better decisions.

Stocks

Stocks, also known as shares or equities, represent ownership in a company. When you buy a stock, you become a shareholder and have a claim on the company's net worth and earnings. Companies that issue stock are called publicly traded. Their shares are bought and sold on exchanges such as the New York Stock Exchange and the Nasdaq.

Types of Stock

Common stock is the type of stock most often issued by companies. Shareholders collectively own the company and have voting rights on some corporate matters. Common stockholders have the potential to earn dividends and participate in the company's growth and success. However, they are generally the last to receive any remaining assets if the company goes bankrupt.

Preferred stock is a class of stock that offers shareholders preferential treatment over common stockholders. They receive dividends before common stockholders. In the event of bankruptcy, preferred stockholders have priority in receiving their investment back. However, preferred stockholders usually do not have voting rights or the same potential for capital appreciation as common stockholders.

Categories of Stock

Growth stocks are shares of companies expected to grow at an above-average rate compared to other companies in the market. These companies typically reinvest their earnings back into the business to fuel further growth. Investors buy growth stocks with the expectation that the stock price will increase over time.

Value stocks are shares of companies that are considered undervalued or trading at a lower price relative to their intrinsic value. Investors who focus on value investing look for stocks that they believe are priced lower than their fundamental worth. They seek to capitalize on market inefficiencies and anticipate that the stock's price will eventually rise to reflect its true value.

Dividend stocks are shares of companies that distribute a portion of their earnings to shareholders in the form of dividends. These stocks are favored by investors seeking regular income from their investments. Dividend payments are typically made quarterly, although the amount and frequency can vary among companies.

Blue-chip stocks are shares of large, well-established, and financially stable companies with a history of reliable performance. These companies are often leaders in their respective industries and are considered relatively safe investments. Blue-chip stocks are known for their stability and tend to pay dividends consistently.

Stocks are also categorized by market capitalization, which is the total value of a company's outstanding shares. Small-cap stocks have a relatively small market capitalization, typically under a few billion dollars, while mid-cap stocks have a market capitalization, usually between a few billion and tens of billions of dollars. Large-cap stocks refer to the largest companies with market capitalizations typically exceeding tens or hundreds of billions of dollars. Different investors may focus on different market capitalizations based on their investment strategies and risk tolerance.

Bonds

Bonds are debt instruments issued by governments, municipalities, and corporations to raise capital. When you buy a bond, you are lending money to the issuer for a specified period. In return, the issuer pays you regular interest payments and returns the principal amount at maturity. Bonds have varying maturities, interest (coupon) rates, and credit ratings.

Types of Bonds

Treasury bonds are issued by the government of the United States. They are backed by the full faith and credit of the federal government, making them low-risk investments.

Municipal bonds are issued by state and local governments to finance public projects such as schools, highways, or infrastructure. They offer tax advantages since the interest income is often exempt from federal taxes and may also be exempt from state and local taxes, depending on the issuer and where the bondholder resides.

Agency bonds are issued by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac, or other government agencies. Agency bonds are often considered to have a level of credit risk between government bonds and corporate bonds.

Corporate bonds are issued by companies to raise capital for various purposes, such as expanding operations or funding projects. Corporate bonds typically offer higher yields than government bonds since they have a higher level of risk, which varies depending on the creditworthiness of the issuing company.

Bond Credit Ratings

Bonds are assigned ratings by credit rating agencies to indicate their creditworthiness and the risk of default. The most used credit rating agencies are Standard & Poor's (S&P), Moody's, and Fitch Ratings. Ratings typically range from AAA or Aaa (the highest rating indicating the lowest risk) to D (default).

Two common ratings groups are:

Investment grade, which are bonds with higher credit ratings, usually ranging from AAA/Aaa to BBB/Baa. They are considered to have a lower risk of default and are more likely to make interest and principal payments as scheduled.

High-Yield or Junk, which are bonds that have lower credit ratings, typically below BBB/Baa. They offer higher yields to compensate for the increased risk of default. Investors who purchase high-yield bonds are taking on a higher level of risk in exchange for potentially higher returns.

Investing in Stocks and Bonds

It takes a lot of time to learn and stay abreast of economic and market trends. If you’re busy in other areas of your life, consider mutual funds and exchange traded funds as a vehicle for investing in stocks and bonds. (See my article on Mutual Funds & ETFs)

If you’re thinking you may want to manage your own portfolio, it's important to note that investing involves risks. Consider seeking advice from a financial professional who can help you gain a better understanding of your circumstances and the markets and can provide personalized guidance based on your financial goals, risk tolerance, and time horizon.

Prepare by taking the following steps:

Educate Yourself: Before investing, take the time to learn about stocks and bonds, how they work, and the associated risks. Understanding fundamental concepts like risk tolerance, diversification, and asset allocation will be valuable.

Set Clear Goals: Define your investment objectives, whether it's long-term wealth accumulation, saving for a specific goal, or generating income. Clear goals will help you determine the appropriate investment strategy.

Determine Risk Tolerance: Assess how much risk you can tolerate, which depends on your financial situation, time horizon, and comfort with market fluctuations. Stocks generally offer higher returns but also greater volatility. Bonds are typically more stable but may have lower returns. Ask yourself, will I sleep well if I make these investments?

Diversify Your Portfolio: Spread your investments across different asset classes, sectors, and geographies to reduce risk. Diversification helps to mitigate the impact of a single investment's poor performance on your overall portfolio.

Research and Select Investments: Conduct thorough research on potential stocks and bonds you're considering. Analyze financial statements, company performance, and industry, market, and economic trends. For stocks, assess factors like earnings growth, dividends, and valuation metrics. For bonds, consider credit ratings, yields, and the issuer's financial health.

Dollar-Cost Averaging: Consider implementing a dollar-cost averaging strategy, where you invest a fixed amount at regular intervals (e.g., monthly). This approach reduces the impact of short-term market volatility and allows you to buy more shares when prices are lower and fewer when prices are higher.

Stay Informed: Keep up with financial news, market trends, and any updates on the companies or bonds in which you invest. However, avoid making investment decisions based solely on short-term market fluctuations or noise.

Monitor and Review: Regularly review your investment portfolio's performance, adjusting as needed to stay aligned with your goals and changing market conditions. Rebalancing your portfolio periodically can help ensure it remains diversified.

Remember, investing is a long-term endeavor, and it's crucial to have realistic expectations. The stock and bond markets can be volatile, so it's important to be patient, stay focused on your goals, and make informed decisions based on your risk tolerance and investment horizon.

Where are you on this journey? Have you set your financial goals?

How can I help you? Call, text, or email me.

Kevin

P.S. Don’t miss this week’s episodes of The WAY to WOW Shows:

Monday, July 17, 10:00 a.m. PT / 1:00 p.m. ET – Trusts & Estate Weekly on Power of Attorney.

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Tuesday, July 18, 11:00 a.m. PT / 2:00 p.m. ET – Business Lessons from the Military resumes the discussion of Marine Corps Warfighting doctrine.

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Wednesday, July 19, 12:30 p.m. PT / 3:30 p.m. ET – People Making Money, with my guest Paul Mackiewicz, CEO/Founder of Honorable Marketing.

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