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. Which factors most influence fixed income securities?

    Learn about the main factors that impact the price of fixed income securities, and understand the various types of risk associated ... Read Answer >>
  2. How does a bond's coupon interest rate affect its price?

    Find out why the difference between the coupon interest rate on a bond and prevailing market interest rates has a large impact ... Read Answer >>
  3. Why do bond coupon rates vary so greatly?

    Learn about the two major reasons that cause bond coupon rates to vary so dramatically and what role coupons play in the ... Read Answer >>
  4. Can Mutual Funds Only Hold Bonds?

    Find out which mutual funds include only bonds in their portfolios. Learn why some funds invest in different types of bonds ... Read Answer >>
Related Articles
  1. Taxes

    What You Need To Know About Capital Gains And Taxes

    Find out how your profits are taxed and what to consider when making investment decisions.
  2. Managing Wealth

    Understanding Capital Gains

    Capital gain refers to the increase in value of a capital asset or an investment security upon sale. In other words, if you buy company stock, real estate or fine art and then sell it for more ...
  3. Taxes

    Capital Gains Tax 101

    Find out how taxes are applied to your investment returns and how you can reduce your tax burden.
  4. Investing

    The Basics Of Municipal Bonds

    Investing in these bonds may offer a tax-free income stream but they are not without risks.
  5. Personal Finance

    All About Income

    Income is the money you or a business earns by providing goods or services, or through investments.
  6. Investing

    Common Bond-Buying Mistakes

    Avoid these errors made daily in bond portfolios everywhere.
  7. Taxes

    Tax Tips For the Individual Investor

    Keep more of your money in your pocket with these seven guidelines.
  8. Financial Advisor

    7 Questions to Consider Before Investing in Bonds

    There is a significant number of questions every investor, private or institutional, should consider before investing in bonds.
RELATED TERMS
  1. Income Investment Company

    A money management firm whose primary investment goal is to generate ...
  2. Return On Capital Gains

    The return that one gets from an increase in the value of a capital ...
  3. Capital Gains Tax

    A type of tax levied on capital gains incurred by individuals ...
  4. Net Investment Income

    Income received from investment assets (before taxes) such as ...
  5. Capital Gain

    1. An increase in the value of a capital asset (investment or ...
  6. Bond

    A debt investment in which an investor loans money to an entity ...
Hot Definitions
  1. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
  2. Buyback

    The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies ...
  3. Tax Refund

    A tax refund is a refund on taxes paid to an individual or household when the actual tax liability is less than the amount ...
  4. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced within a country's borders in a specific time period, ...
  5. Inflation

    The rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of ...
  6. Merchandising

    Merchandising is any act of promoting goods or services for retail sale, including marketing strategies, display design and ...
Trading Center