Wondering what the difference is between the equity and fixed income markets, and how to decide where to invest your hard-earned dollars? Here’s our primer on these two types of investments.
When it comes to equity vs. fixed income investing, there are some major differences, including the types of securities that are traded, the level of risk involved, and the expected returns. Even the profile of the average investor for each type of investment tends to be somewhat different.
Here’s a quick look at some of the top things differentiating the two:
|EQUITY INVESTMENTS||FIXED INCOME SECURITIES|
|Trading dominated by:||Stocks||Bonds|
|Relative risk level: ||High||Low|
|Relative expected returns:||High||Low to moderate|
|General nature of investors: ||Aggressive||Conservative|
*See endnote for information about this chart.
Equities are bought and sold via stock markets, including the big ones you’re familiar with: the New York Stock Exchange (NYSE) and the Nasdaq. The market value of a stock is likely to rise and fall based on a company’s earnings, the state of the economy, and broader stock market trends.
When you buy a stock, it provides you with partial ownership of the issuing company. Stocks are either “common” stocks (which provide owners with the right to claim the issuing company’s assets, receive dividends, and vote at shareholder meetings) and “preferred” stocks (these provide a claim on the company’s assets and dividends, but do not come with voting rights).
Between equities and bonds, stocks are typically the riskier of the two and are subject to greater volatility. On the other hand, their potential returns are typically higher.
Fixed Income Investments
Fixed income investments represent loans extended to corporations or governments by investors. When a company or government needs additional funds, they may issue what are called bonds (sometimes known as debt securities) to get that funding, which comes from investors.
There are several different types of bonds, but corporate bonds, municipal bonds, and treasuries (a.k.a. T-bonds, issued by the U.S. Treasury) are the most common.
Why are bonds called “fixed income” investments? Because investors are helping to finance a debt on the part of an entity, they receive a return as regular income on the interest for that loan. Many retirees need to have stable income that they can count on, and this is where bonds come in: Even though they may not offer the exhilarating high returns that stocks might, they have historically added relative safety to a portfolio and can help minimize the volatile effects of markets.
Rather than buying individual bonds directly, most investors access bonds via a bond exchange-traded fund (ETF) or bond mutual fund. These investments pay monthly or quarterly dividends.
The Best Approach? Balance
So, which type of investment should you choose? In our view, the answer is both.
Both equities and fixed income investments help you as an investor achieve your financial goals. It’s important to have an optimal mix of both types of securities in order to maximize your investment potential. And because these two kinds of investments respond differently to different financial conditions, a balance of both is also key to weathering the ups and downs that come with investing.
What is that so-called optimal mix? It depends entirely on your personal financial situation and goals. Your wealth advisor will be able to help you bring that balance in the context of your current financial situation and goals for retirement. He or she will help you adjust how your portfolio is diversified across different types of investments (your asset allocation) according to your needs, always keeping in mind the big picture of your financial plan.
Need some additional guidance in shaping your financial plan and finding the optimal portfolio mix for your goals? Ironwood Wealth Management is here to help you get and stay on track. Contact us today.
*Endnote: “Relative risk level,” “Relative expected returns,” and “General nature of investors” are based on historical risk and return metrics of U.S. large company stocks and AAA corporate bonds.