Individuals have access to a variety of investment vehicles that can be used to help them meet their short and long-term goals. The suitability of one investment over another depends largely on the individual’s financial situation and his or her own preferences, priorities and tolerance for risk. For those individuals, with excess funds, who have built a solid foundation of savings, protection and diversification of their investments, individual securities such as stocks and bonds, may present a suitable opportunity to achieve additional growth and income. As these investments entail substantial risk, investors need to develop a sound knowledge of their use as well as a clear understanding of their potential risks.
Publicly owned companies, as the name implies, are owned by the public, consisting of individuals and institutions that purchase a fractional interest or share of the company. Their interest is represented by the shares of stock that are issued by the company. This is a way for companies to raise capital that can be used to fund its growth.
If the company is successful and grows, the stockholders share of the company can increase in value. If the company is not successful, the shareholder could lose value in his shares. There is also the possibility that shareholders can participate in the profits if the company’s Board of Directors declares a “dividend”.
Stock values reflect the current valuation of a company as well as its near-term prospects for achieving earnings growth. While some companies may have good long term growth prospects, there are many factors that can cause the stock’s price to fluctuate in the short term. Investors who buy a stock when the market is moving up, may find themselves in a position to have to sell the stock when the market is moving down, which could result in a capital loss. Losses or gains are not realized until the stock is actually sold.
Over time, stocks have the potential to generate returns that can outperform other investments. They are typically bought by investors who seek long term growth. Stocks that pay dividends can also be a source of current income for investors.
In addition to raising capital by selling ownership shares, companies can also borrow money from the public by issuing debt securities. When an individual or institution buys a bond from a company, they become a bondholder and they receive interest from the company. At the time the bond matures, or comes due, the bondholder receives the principal back.
Bonds are issued at full face value with a specific interest rate affixed to it. A $1000 bond with a 5% yield will generate $50 of interest payments each year. Because bonds are sensitive to the movement of interest rates, their values will increase or decrease as rates move down or up. If an investor sells a bond on the open market, he could receive an amount that is greater or less than the original face value.
Like stocks, bonds can be traded on the open market. If a bond is sold before maturity, its market value may be less than its original face value. Bonds held to maturity will be redeemed for their principal amount, but there is a risk that the issuing company could encounter financial difficulties and default on the bond. When interest rates rise, the market value of existing bonds may decline, particularly if their coupon rates are lower than current market rates. Conversely, when interest rates fall, the market value of existing bonds may increase.
Bonds are typically purchased by investors who are seeking current income. Because bonds have the potential to increase in value, there is also the potential to achieve long term growth.
Governments, at various levels such as cities, states, and municipalities, utilize a method known as municipal bonds to raise funds for public projects. When individuals or institutions invest in municipal bonds, they effectively lend money to the government entity issuing the bond. In return, the bondholder receives regular interest payments, and upon the bond's maturity, the bondholder is repaid the principal investment.
Municipal bonds are introduced with a predetermined face value and interest rate. For instance, a $1,000 municipal bond with a 4% yield would result in $40 in annual interest payments. Comparable to other bond types, the value of municipal bonds can fluctuate due to shifts in interest rates. As interest rates rise or fall, the market value of these bonds might experience corresponding increases or decreases. Should an investor decide to sell a municipal bond on the open market before its maturity, the received amount could differ from the original face value.
Potential Tax Advantages:
One of the notable features of municipal bonds is their potential tax-favorable treatment. The interest income generated from most municipal bonds is often exempt from federal income taxes. Moreover, if the investor resides in the same state as the issuing government entity, the interest income can also be exempt from state and local taxes. This tax-favorable treatment can make municipal bonds an attractive choice for investors seeking to minimize their tax obligations while generating income.
Similar to corporate and other bonds, the market value of municipal bonds may be lower than their original face value if they are sold before maturity. While bonds held until maturity typically result in the redemption of their principal amount, there's a risk that the government entity issuing the bond could face financial challenges and default. Changes in prevailing interest rates can affect the value of municipal bonds. When interest rates rise, the market value of existing bonds may decline, particularly if their coupon rates are lower than current market rates. Conversely, when interest rates fall, the market value of existing bonds may increase.
Investors often consider municipal bonds as a means of generating current income. Additionally, because the value of these bonds can appreciate, there exists the potential for long-term growth.
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