How does a person gain from an investment?

By Chad Langager AAA
A:

There are two main ways in which a person gains from an investment. The first is by capital gains, the difference between the purchase price and the sale price of an investment. The second is investment income, the money paid to the holder of the investment by the issuer of the investment. Depending on the type of investment, the source or mix of the total gain will differ. And in some cases, these different sources are taxed at different rates, so it is important to be aware of each.

All stocks can generate a capital gain as the price of a stock is constantly changing in the market. This allows you to potentially sell for a higher price than what you bought the stock for originally. Some stocks also generate income gain through the payment of dividends paid out by a company from its earnings. For example, say that you bought a stock for $10 and the company pays off an annual dividend of $.50, and after two years of holding the stock you sell it for $15. Your capital gain is 50% ($5/$10) and your income gain is 10% ($1/$10) for a total gain of 60% ($6/$10).

Bonds are typically known for their payment of coupons, which is an income source of gain. However, a person also can generate a capital gain from a bond by selling the bond before maturity into the secondary market. For example, if you bought a bond for $1,000 and sold it for $1,100, you would realize a capital gain along with any income gain from coupons paid out to you. There is an inverse relationship between bonds and interest rates, the price of a bond will change in the opposite direction of the prevailing interest rates in the market. If interest rates fall your bond will become come more attractive in the market and be bid upwards.

For more information on gains, see our Investing 101 tutorial.

RELATED FAQS

  1. How long can I hold my HH/H Bonds and still earn interest?

    Take advantage of your bond investment and learn how long you can hold on to your Series H/HH Bonds and still earn interest ...
  2. What determines the price of a bond in the open market?

    Learn more about some of the factors that influence the valuation of bonds on the open market, and why bond prices and yields ...
  3. How long will it take for a bond to reach its face value?

    Learn when different savings bonds reach face value, and determine the best time to cash them in to get the highest return ...
  4. Why should I keep records on my tax-exempt bond transactions?

    Keep your purchase records on all investments, including tax-exempt bonds. Though the interest is tax-free, you may owe taxes ...
RELATED TERMS
  1. Class 3-6 Bonds

    Several classes of noninvestment grade bonds held by an insurance ...
  2. Impact investing

  3. Promotional CD rate (Bonus CD rate)

    A limited-time offer of a higher rate of return on a certificate ...
  4. Direct Bidder

    An entity that purchases Treasury securities at auction for a ...
  5. Indirect Bidder

    An entity that purchases Treasury securities at auction through ...
  6. Bid Wanted

    An announcement by an investor who holds a security that he or ...
Related Articles
  1. With the addition of 'Bond King' Bill Gross, Janus is a changed firm. Here's what its fund lineup looks like now.
    Investing Basics

    How Does Janus's Fund Lineup Look Now?

  2. Blackrock has lowered its fees to snag money leaving Pimco's bond funds. But by how much and who's following suit? Read on.
    Investing Basics

    Thank You, Pimco: BlackRock Drops Bond-Fund ...

  3. What is the difference between corporate bonds and preferred stock? The following are a list of pros and cons for each investment.
    Trading Strategies

    Preferred Stocks versus Bonds: How to ...

  4. How did investors select worthy alternatives so quickly given the majority of the assets were liquidated at a break neck pace following Gross’ resignation?
    Investing

    Why BOND Still Might Be In A Class Of ...

  5. How can you keep more of what you make or made when you retire? Minimize the taxes from short-term trades and taxable interest income.
    Investing

    Keeping More Of Your ETF Capital Gains ...

Trading Center