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Tips to invest in stocks and bonds

Last updated on: October 23, 2009 15:10 IST
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The world has changed with people changing from being cautious about their money to being better risk-takers.

Today, people are more willing to invest in different and new avenues for investments in the hope that their hunch would pay off. All these are aimed at achieving financial independence. Maximising returns and minimising risks is the foremost mantra for investors.

However, you cannot achieve both without doing a little bit of homework, which includes knowing where to invest and how much to invest. Some people look for new investment options while others stick to the time-tested investment options.

Two such time-tested investment options are stocks and bonds. You may know what stocks and bonds are, but you also need to make a choice about which option to focus more on in your portfolio.

This article will help you to understand the basic pros and cons of investing in stocks or bonds and help you make a choice.

Bound to the interest rate - Fluctuation in the values of the bonds occurs depending on the interest rate of the general economy.

For instance, if you have a Rs 1000 bond, which pays the interest of 5 per cent yearly, you can sell it at a higher face value provided the general interest rate is below 5 per cent. And if the rate of interest rises above 5%, the bond, though it can still be sold, is usually sold at less than its face value.

Fixed rate of return - Unlike stocks, you will not directly benefit from the success of the company or the amount of its profits. Instead, you will receive a fixed rate of return, known as the 'coupon rate' on your bond.

Safety of the investment - Due to the fixed rate of return, whether the company is wildly successful OR has an abysmal year of business, it will not affect your investment. Your bond return rate will be the same. However, there is also the possibility of the principal investment amount NOT being paid back to you.

Obviously, this risk can be somewhat controlled through the careful assessment of the companies or institutions that you choose to invest in.

Maturity dates - Once a bond hits its maturity date, the principal amount paid for that bond is returned to the investor. Different bonds are issued different maturity dates. Some bonds can have up to 30 years of maturity period. Therefore, liquidity could be a concern.

Risk versus return - If you're willing to take a greater risk for better coupon rates, then you would probably end up choosing the companies with low credit ratings, companies that are unproven or unstable.

Keep in mind, there is a great risk of default on the bonds from smaller corporations; however, the other side of the coin is that bond holders of such companies are preferential creditors. They get compensated before the stock holders in the event of a business going bankrupt.

So, for less risk, choose to invest in bonds from established companies and if you have bigger risk appetite, choose to invest in smaller, unproven companies.

Investment risks - As with bonds, you can decrease the risk of stock trading by choosing your stocks carefully, assessing your investments and weighing the risk of different companies.

Value fluctuation - Stocks worth is based directly on the performance of the company. If the company is doing well, growing, and attaining profits, then so does the value of the stock. If the company is weakening or failing, the stock of that company decreases in value.

There are various ways in which stocks are traded. In addition to being traded as shares of a company, stock can also be traded in the form of options, which is a type of Futures trading. Stock can also be sold and brought in the stock market on a daily basis.

The value of a certain stock can increase and decrease according to the rise and fall in the stock market. Because of this, investing in stocks is much riskier than investing in bonds.

In conclusion...

Both stocks and bonds can become profitable investments. But it is important to remember that both options also carry a certain amount of risk. The key to wise investing is always good research, a solid strategy and guidance you can trust.

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