Let’s imagine we had a time machine and we went back in time to 1980 with nothing but $1,000 in cash. 1980 was an important time, because it was the year when Apple first offered their stock to the public at 50 cents a share. With nothing but blind faith, you put all $1,000 into Apple purchasing 2,000 Apple stocks.
As of 2019, Apple stocks are now trading at $235. 40 years later, your $1,000 is now worth $470,000. This is the power of time and making the right choices on which company to invest in.
What are Stocks?
Owning stocks to a company represents owning a part of the company. This means as the company does well, the company value goes up and so does your investment into the company.
Shares however, are not your ticket to buying out a company. For example, if you owned 33% of the shares of a company, it is incorrect to assume that you own 33% of the company. What you do own is 33% of the companies shares so you can indirectly control a company through its board of directors.
The board of directors are a team elected by the corporation’s shareholders to represents the shareholders interest. The board of directors are responsible for evaluating management performance, make major decisions such as acquiring new companies, declaring dividends and establishing executive compensation packages. The more stocks you own, the more influence you have on the board, which indirectly control the direction of the company.
There are 2 types of stocks: common and preferred. The major difference between common and preferred are that preferred shares comes with no voting rights. Similar to our previous example, if you own 33% of the stocks, you will still gain the benefits when the company does well, but you will no longer have any control over the board of directors.
Here’s a quick summary of the differences:
What are Bonds?
Think of bonds as similar to a loan. When you loan a sum of money, you expect 2 things: a date when the debt is repaid, and to earn a little interest. In respect to the stock market, organizations such as government agencies or corporations’ issues how much money they want to borrow and at what interest rate, and you the investor can fill part of all of the amount.
Similar to stocks, bonds can also increase in value. Since bonds return a fixed return, they are attractive to investors during times of economic recession. Therefore, you can sell the ‘loan’ that the organization owes to you to another person at a higher value.
There are 4 major types of bonds:
- Treasury Securities: Treasuries are backed by the full faith and credit of the U.S. government as to the timely payment of principal and interest, so there is little risk of default.
- Municipal Bonds: Municipal bonds are issued by state and local governments to fund the construction of schools, highways, housing, sewer systems, and other public projects.
- Corporate Bonds: Corporations may issue bonds to fund a large capital investment or a business expansion. Corporate bonds tend to carry a higher level of risk as they can default on the loans.
- Zero-Coupon Bonds: This type of bond does not pay out interest rate on a monthly or yearly basis, but it pays out the interest upon maturity.
Stocks vs. Bonds
To first understand the differences, here’s the breakdown the differences.
The general rule is during times of recessions, it’s more advantageous to purchase bonds since the interest rates are fixed and therefore the income you’ll earn from bonds will continue vs stocks where recession will most likely impact the corporations bottom line, and reduce the value of the stock.
Recessions however are a great time to purchase stocks because they can be undervalued. The stock market is nothing but simple supply and demand. As fears rises during a recession, stock holders will sell at the “higher price” and wait for the price to drop and rebuy at the undervalued price.
As a beginner investor, I would not recommend trying to time the market but focus on the stock to bond ratio. There is no “right” answer to how much you should allocate to stocks over bonds, but the generally rule is that the older you get, the less risk you should take.
Here’s our recommendation to calculate how much you should allocate to stocks based on your age.
The biggest mistake is not investing into the market as soon as you can because of fear. Stocks is the best example of the domino effect. By investing money now, it has the potential to provide exponential returns in the future. I’ll leave you with a short video on the domino effect.