Investing Basics for Physicians: What Are Stocks and Bonds?
By Jared Andreoli, CFP®, CSLP®
Congratulate yourself! If you’re already sticking to a budget and have already established the right type of investment account, you’re well on your way to pursuing a solid investment strategy. Now it’s time to learn the answer to “What are stocks and bonds?” so you can choose the right investments and to help meet your long-term money goals.
Let’s take a look at the fundamentals of stock and bond investing and how to choose the smartest strategy for your situation.
What Are Stocks and How Do They Work?
Simply put, stocks are shares of ownership in a company, including a claim on the company’s earnings and assets. Once you buy a stock, you’re officially a partial owner of that company. When the value of the company increases or decreases, so does the value of your stock.
The New York Stock Exchange (NYSE) and the National Association of Securities Dealers (NASDAQ) are the two main stock exchanges in the United States. Exchanges are where stocks are typically purchased and sold electronically. While some businesses offer shares to investors directly, the majority only do so through brokerages.
Buying and selling stocks can be done for a variety of reasons, such as the chance to increase the value of the investment over time, leverage more transient changes in stock prices, or even generate income from dividend-paying companies.
Remember, though, that a stock’s price can drop just as quickly as it can climb. The value of a company’s shares typically increases when it’s operating well. Similarly, if their performance declines, the price can drop.
What Are Bonds and How Do They Work?
A bond is a loan that pays investors a fixed rate of return. The investor earns interest on their investment, and the borrower uses the funds to support their operations.
When you buy a bond, you’re essentially lending money to an organization that repays you with interest. In general, bonds are considered less risky than stocks and are typically used by investors who want to add stability to their portfolios.
Even while bonds are usually thought of as a less risky investment than stocks, it’s crucial to remember that they’re not completely infallible. You can end up receiving less than what you paid for your bond if you decide to sell it before it matures. You can also lose money if the bond’s issuer stops making payments.
Stocks vs. Bonds
The biggest difference between stocks and bonds is that stocks give you a minor stake in a company, while bonds allow you to lend money to a company or government entity.
Another distinction between the two is how they generate income for you: bonds provide fixed interest over an extended period of time, whereas stocks need to increase in value in order to be sold for a profit.
Let’s look at an example.
Imagine you invest $1,000 in both a stock and a bond.
Over five years, the company experiences significant growth, and the stock price doubles. Your investment is now worth $2,000, providing a $1,000 profit. However, if the company underperforms and the stock price drops by 50%, your investment falls to $500, resulting in a $500 loss. Stocks have the potential for substantial gains, but they also carry the risk of significant losses.
The $1,000 bond you bought pays a 5% interest rate annually, so your return is $50 per year. When the bond reaches maturity (the amount of time you agreed to own the bond), you get your initial $1,000 back, plus the accumulated interest of $250, making the total $1,250.
As you can see from the example, your $1,000 stock investment is riskier, but has a greater potential return. Your $1,000 bond investment, on the other hand, is more reliable but comes with a much lower return.
Having a thorough understanding of these distinctions allows you to select the option that most closely aligns with your risk tolerance and financial planning objectives.
Make the Right Choice
Stocks and bonds each have unique characteristics. Selecting the right one for your investing objectives can be challenging, and working together with a professional financial advisor can be a big help.
At Simplicity Financial LLC, each client’s investment plan is individualized to reflect their goals. Using this specific goal-based investment approach allows our clients to better track their progress. We believe in controlling what you can control, which is why each of our clients has an investment portfolio that is diversified, tax-efficient, and low-cost.
Get started today by scheduling a free consultation, or reach out to us by emailing jared.andreoli@simplicityfinancialllc.com or calling 414-207-6473.
About Jared
Jared Andreoli, CFP®, CSLP®, is president and financial planner at Simplicity Financial, a fee-only RIA dedicated to helping early-career physicians conceptualize their financial picture and achieve their financial goals. Jared specializes in devising individualized financial road maps for clients, and he loves nothing more than a full day meeting with clients who value his partnership to solve problems—big and small.
After college, Jared spent six years working as a mutual fund administrator for a large company. While he learned an immense amount about the financial world, he was missing the personal connection of working with individual clients. Combining his passion for finance and personal connection, he established Simplicity Financial in 2017.
Jared has a degree in finance with a concentration in financial planning from Western Kentucky University, along with the CERTIFIED FINANCIAL PLANNER® (CFP®) and a Certified Student Loan Planner (CSLP®) certifications. Outside of work Jared enjoys cooking and traveling. He played baseball in college and still coaches occasionally. He and his wife recently welcomed a daughter, who occupies most of their time. To learn more about Jared, connect with him on LinkedIn.