Since 1926, the average annual return on stocks has exceeded 10%. The return on bonds has been 5% and on cash reserves less than 4%. If you invested $167 per month ($2,000 per year) for 25 years, you would have $221,581 at 10%, $99,450 at 5% and $85,860 at 4% earnings. With higher returns through the stock market, it is no wonder that more investors buy stocks and mutual funds each year. Although stocks offer the potential for higher returns over bonds and cash reserves, they also expose you to more risk, particularly in the short term. Remember that historical average returns do not assure future returns.
Stock is a security that represents ownership in a corporation. A bond, by contrast, is debt issued by the company, basically an IOU. Bondholders are lenders; stockholders are owners. In the event of trouble, bondholders have a superior claim, but they don't share in the company's success the way stockholders do.
When you buy company stock, you can make money in one of two ways: through dividends, or through price appreciation when you sell your shares. The dividend payment you receive reflects your share of the company's profits. Dividends are usually paid quarterly. However, some companies don't pay dividends at all. Whether or not you make a profit when you eventually sell your shares will depend on a variety of factors, including the company's success, whether its particular industry is doing well and whether the stock market is rising or falling (maximizing returns will be discussed in a later article).
There are two basic categories of stock, preferred and common. Preferred stock is a hybrid between debt (bonds) and equity (stocks) exhibiting characteristics of both. Preferred stock pays a fixed dividend, has a preferred claim over the common stock to the dividends of the company and is given preferential treatment if the corporation is liquidated. While the dividends are greater and more stable than co...