Why Are Stock Funds Riskier Than Bond Funds
Below is a MRR and PLR article in category Finance -> subcategory Wealth Building.
Why Are Stock Funds Riskier Than Bond Funds?
Summary
Conventional investing wisdom suggests that stock mutual funds are riskier than bond funds. This article explores the differences in risk between stocks and bonds and discusses how to allocate investments between stock and bond funds.Understanding Stocks and Bonds
Stocks represent partial ownership in a business. In contrast, bonds function more like a loan to that business. When purchasing a bond, assuming the issuing company remains solvent, you know exactly how much you'll receive back and when. For example, a bond with a 6% yield typically pays a 3% dividend twice a year. By holding the bond until maturity, you'll eventually receive its face value, say $10,000, but this requires holding it for 20 to 30 years.
Risks Associated with Bonds
While bonds offer predictable cash flow, there's always a risk that you might need to sell before maturity. If interest rates rise, you could receive less than the bond's face value in the open market. Conversely, if rates fall, you might get more. Another risk is with "callable" bonds, where the issuer can redeem the bond early, typically when interest rates drop, allowing them to reissue at a lower rate.
Comparing Risk: Stocks vs. Bonds
Compared to bonds, stocks have uncertain cash flows, making them riskier. However, stocks can significantly appreciate over time. A stock appreciating by 10% annually could be worth more than eight times its initial value after 30 years.
Bonds in Investment Portfolios
Most investors hold bond mutual funds rather than individual bonds, especially in retirement portfolios like IRAs and 401ks. Unlike individual bonds, bond funds don't have a final maturity date, which affects their behavior and risks. This difference challenges the notion that stocks are always riskier than bonds.
Portfolio Allocation: Stocks vs. Bonds
Determining how much of your portfolio to invest in stock funds versus bond funds requires careful consideration of your financial goals and risk tolerance.
By understanding the characteristics and risks of stocks and bonds, you can make informed decisions about your investment strategy.
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