| it of conventional investing wisdom is that stock | | | | There is one other risk that many investors are |
| mutual funds have much more risk than bond | | | | unaware of. It comes into play with a "callable" |
| funds. In this article we take a look at how stocks | | | | bond. In this case, the company issuing the bond |
| and bonds will have differing risks. We will also | | | | has the right to redeem, or call, that bond before |
| look at how much we should invest in stock funds | | | | its final maturity. A company may want to call a |
| vs bond funds. | | | | bond if interest rates had fallen, so they could |
| Stock represent a partial ownership in a business. | | | | then reissue the bond at the lower market |
| But bonds are set up more like a loan to that | | | | interest rate. |
| business. Upon examining a typical bond issue, if | | | | With that as background, we can see that stocks |
| you ignore the risk that the issuing company | | | | are riskier than bonds because bonds will have a |
| might go bankrupt at some point, you find that | | | | fairly certain cash flow for the bondholder, while |
| you know precisely how much money you will | | | | the company's common stock will have anything |
| receive back and when you will receive it. Take | | | | but a certain cash flow. But the other side of that |
| this case as an example, if you bought a bond | | | | coin is that a stock has the potential to appreciate |
| with a 6% yield on that bond, it will probably be | | | | greatly in value. For example, if a stock were to |
| paid as a 3% dividend every twice a year. If you | | | | appreciate 10% a year, in 30 years it will be |
| hold that bond issue to its final maturity, you will | | | | worth more than 8 times its original value. |
| receive the face value of the bond back, say | | | | One key thing to note about bonds in individual |
| $10000. The key thing to note is that you would | | | | portfolios. Most people don't hold individual bonds in |
| have to hold it 20 or 30 years to receive all your | | | | their investment portfolio. They are more likely to |
| money back. | | | | have bond mutual funds. This is often the case in |
| But, as we all know, there is always some risk | | | | retirement portfolios like IRAs and 401ks. But |
| that you will not be able to hold the bond to its | | | | bond funds behave quite a bit differently than |
| final maturity date. In that case, you can always | | | | individual bonds, since they don't have a final |
| sell it on the open bond market, but if prevailing | | | | maturity. The difference is so great that the |
| interest rates have risen, you will receive | | | | conventional wisdom that stocks are riskier than |
| somewhat less than face value of the bond in the | | | | bonds may no longer be true. |
| open market. Of course, if you were fortunate or | | | | So all this begs the question, how much of your |
| smart enough to hold a bond while interest rates | | | | portfolio should you invest in stock funds vs bond |
| go down, you could actually receive more than | | | | funds... |
| face value for your bond. | | | | |