Stock investing and bond investing have much in common. If you want quality you pay for it. If you take more risk you can make more money. You can invest in the individual securities or in funds: stock funds and bond funds.
Let’s look at bond investing basics first. High quality bonds and high quality bond funds have less credit risk. This is comforting because you are lending money to make money when investing in bonds. Your goal is to earn higher interest with relative price stability. High quality bonds and bond funds pay less interest than lower rated securities, all else being equal.
In other words, in bond investing you pay for high quality. In simplest terms, you take more risk and earn more interest if you accept lower quality. The other basic way to earn more interest is to invest in long-term bonds and bond funds vs. short-term securities. Even with tax-free municipal bonds quality and time to maturity will determine risk and rate of interest.
Traditional blue chip stocks and stock funds that invest in them are of the highest quality and have excellent track records for paying dividends. Once again, under normal circumstances you pay for this high quality and lower risk. To increase your profit potential you can forego a steady dependable dividend and go with growth stocks. Or, you can go with less established or smaller-company stocks and take more risk hoping to make money from a significant rise in stock price.
Stock investing and bond investing both involve a tradeoff of quality and stability vs. more risk and higher profit potential. That said, there is at least one other major similarity. Higher inflation and higher interest rates (the dynamic duel) work against both of them. We haven’t seen interest rates and/or inflation on the rise in years. That’s why most people buy the line that if you own both securities… stocks and bonds… losses in one will be offset by gains in the other.
Bonds and bond funds lose value when interest rates and inflation increase. Period. Stocks and stock funds got crushed in 1973-1974 and again in the early 1980’s when the dynamic duel headed north together. Corporate profits fell and the stock market followed suit.
I cringe when I hear self-proclaimed experts say that it’s easy to make money investing. That was the case from 1982 through the year 1999. It has not been the case since, and interest rates and inflation have been tame and cooperative. To make money investing over the next few years you will need a sound investment strategy.
And you will need to keep an eye on both interest rates and inflation – the dynamic dual and possibly your worst investment partner.
A retired financial planner, James Leitz has an MBA (finance) and 35 years of investing experience. For 20 years he advised individual investors, working directly with them helping them to reach their financial goals.
Jim is the author of a complete investor guide, Invest Informed, designed for average investors or would-be investors of all levels of financial background and experience. To learn more about investments and investing and his new financial guide go to http://www.investinformed.com.