About bonds vs. stocks
Is it better to invest in bonds than in stocks, because they’re safer? — T.W., Columbia, Missouri
Not necessarily. Stocks tend to grow faster — and you can still lose money with bonds. According to researcher Jeremy Siegel, stocks outperformed bonds in 96% of all 20-year holding periods between 1871 and
2012 and in 99% of all 30year holding periods. Between 1926 and 2012, the annualized growth rate for stocks was 9.6%, versus 5.7% for long-term government bonds.
Meanwhile, interest rates have been very low for many years now, so they’ll likely start rising one of these years. When they do, the value of existing bonds (with lower interest rates) are likely to drop. You can always hold a bond until maturity to get your full principal back, but that can take a long time.
The values of bond mutual funds can fluctuate with the bond market; they often hold a diverse range of bonds to reduce risk. The stock market can be volatile over a few months or years, but over the long run, it tends to rise. Park long-term dollars in stocks, and put short-term savings in short-term bonds, money market accounts or CDs.
Macro- and microeconomics
If you’re interested in investing in stocks, you’d do well to learn about both macroeconomics and microeconomics, as they can help you understand the headwinds and tailwinds that can affect nations and businesses. Remember, if you own a share of stock in a company, you’re a part owner in it, and will gain or lose depending on how it performs.
Macroeconomics takes a big-picture view on a regional, national or global level. It examines the interplay between inflation, unemployment, gross domestic product, public debt, fiscal policy and overall supply and demand — trying to answer questions such as, “What will spur economic growth?” It can help you understand how well your own country’s economy is functioning, and it can help you spot other economies that might be fertile hunting grounds for investments.
Microeconomics is even more useful for investors, as it focuses on particular companies or industries, looking at factors such as supply and demand, labor markets, costs of production, price elasticity of demand (how flexible consumers are in what they’re willing to pay), and competitive advantages. It examines the behavior of buyers, sellers and businesses, and observes or predicts the results of various actions, such as lowering prices or raising wages.
Competition is critical for investors to understand, because the best companies in which to invest often have sustainable competitive advantages. These might include a powerful brand, patents and other intellectual property, scale, and/or steep barriers to entry that prevent new rivals from materializing. Think of airplane manufacturers — it’s hard for any new company to fund the facilities and equipment needed.
The microeconomic concepts of monopoly and oligopoly (when a market is controlled by just a few companies) are also good to understand. A company that’s a near-monopoly has great freedom in how it prices its offerings, while companies in very competitive industries do not. Thus, investors often prefer companies that are monopoly-like, though anti-trust actions could threaten them one day.
Like accounting and even psychology, economics is a helpful subject to know if you want to be a better investor.