| Every investment involves some amount of risk | | | | because as mentioned earlier, bank and building |
| taking, and as a rational investor, your aim should | | | | society deposits, vie for the funds of individuals. |
| be to maximise your returns as much as possible, | | | | When interest rates rise, bank and building society |
| to obtain the best compensation for whatever | | | | deposits become more competitive, and it is |
| level of risk you decide to take. When it comes | | | | necessary for the price of bonds to fall to |
| to earning interest, your savings can either go to | | | | compensate for the lower yields being paid. |
| the bank or building society or to bonds and gilts. | | | | Conversely if interest rates fall, the price of bonds |
| Bonds and bank/building society deposits compete | | | | will rise, so that investors pay for the higher yields |
| for the funds of individuals, and thus usually have | | | | they can earn. |
| the same trend (rise or fall) in interest rates and | | | | A booming economy normally has businesses as |
| yield. Concerning yields, the longer the maturity, | | | | well as individuals chasing a lot of money to invest |
| the higher the expected compensation or yield. In | | | | in production and to spend on day to day |
| order to comprehend the need for both equities | | | | activities. The forces of demand and supply kick |
| and bonds in your portfolio, you must first fathom | | | | in, and hence increases the price of borrowing, |
| the relationship between interest rates, inflation, | | | | which is interest rate. A boom also tends to |
| strength of currency and the well-being of an | | | | trigger inflation, and a fall in currency, which |
| economy. | | | | benefits equity holders, but affects bond holders |
| When one invests in a share/equity, what has | | | | negatively as afore-said - a rise in interest rates |
| fundamentally happened is that an ownership has | | | | leads to a fall in price of bond, and the increase in |
| been purchased in the company that is being | | | | inflation devours the real value of the yield. The |
| considered. This means that one can make | | | | opposite of this combination of effects can be |
| decisions and also share in the profits of the firm. | | | | anticipated during a recession. Since the future is |
| Profits are distributed in the form of dividends, | | | | fairly uncertain, and one cannot accurately predict |
| and it is the directors of the firm that decide how | | | | whether there will be a boom or recession, an |
| much dividend they want to pay out of profits. In | | | | investment that encompasses both equities and |
| fact, where all profits are reserved for growth, | | | | bonds stands to gain whether there is economic |
| no dividends at all are paid sometimes, a practice | | | | recession or boom. |
| very typical of small and new companies. It must | | | | The bottom line is that a mix of equities and |
| also be noted that the money that is invested, | | | | bonds in a portfolio allows the investor to even |
| unlike an investment in bonds, cannot be | | | | the downs of one security with the ups of the |
| redeemed. One good benefit of equities, though, is | | | | other, whether there is a boom or recession. It is |
| that it protects investors from the sting of | | | | akin to the benefits enjoyed by a man I know |
| inflation. This is because firms tend to make more | | | | who goes to Africa during the winter months, |
| profits and their shares tend to pick up value, as | | | | because the weather there at that time of the |
| inflation rises. This shelter from inflation is | | | | year, is really sunny and dry. When the rainy |
| nevertheless denied bond investors, whose real | | | | season starts in June/July, he will be nowhere to |
| yields, will be very much impinged upon by a rise | | | | be found! Where do you think he will be? Back in |
| in inflation. | | | | England to have his share of the brightness of |
| It is rewarding to be aware of the inverse | | | | summer! In effect the access to England and |
| relationship that exists between the price of | | | | Africa, like having a mix of bonds and equities, |
| bonds and interest rates. When interest rates rise, | | | | does not make him experience the torture of bad |
| the price of bonds fall and vice versa. This is | | | | weather. |