Stock returns
The returns from owning stocks come from 2 sources.
Cash dividends are earnings that are distributed to shareholders. (Unlike bonds, stocks do not guarantee the timing or the amount of dividends).
At any time, they can be increased, decreased or taken away altogether.
The other source of returns is capital gains. This is the main reason people buy stocks.
The value of your stock may rise when the earning prospects of the company are favourable.
And of course, your shares may also lose value if the company performs poorly.
Bond returns
The returns from owning a fixed-income security come in two forms.
There are the fixed interest payments and the final payment of principal at maturity.
Secondly, there is the potential for capital gains when you sell a bond before its maturity at a price higher than when you purchased it.
Imagine a see-saw. The price of a bond rises when the interest rates fall, and there is thus the possibility of a capital gain from a favourable movement in rates. Of course, inversely, a rise in interest rates will produce a loss.
Money market returns
Money market investments maintain a stable value, pay interest and can easily be converted into cash.
Of the three types of investments, money market instruments pay the lowest rate of return.
So why bother with them?
For the same reason that you leave large chunks of your uninvested money in fixed deposit - safety.
When you buy a money market investment, you are pretty sure you will get your money back with some interest.
The chances of losing money - whether from the government or the bank defaulting on its payment or a loss in principal value of the investment - are very low.
When you invest in a money market investment, you are taking very little risk and your expected return should reflect the amount of risk that you have taken.
When is a money market investment appropriate? When you need to use the money in a year or so, and you want to know that the money will be there with few surprises.
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