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 do deferred tax assets help in meeting retirement goals?

    Learn how tax deferred assets can help individuals achieve long-term financial goals such as retirement and how they differ ...
  2. What is the relationship between the current yield and risk?

    Discover the relationship between a bond’s current yield and risk, and how investors can use it to benefit their overall ...
  3. How does the bond market react to changes in the Federal Funds Rate?

    Discover how the bond market reacts to changes in the federal funds rate. The risk-free rate of return is a major factor ...
  4. How do I use the holding period return yield to evaluate my bond portfolio?

    Find out how to use the holding period return yield formula to evaluate the performance of bonds in your portfolio, and view ...
RELATED TERMS
  1. Accelerated Return Note (ARN)

    A short- to medium-term debt instrument that offers a potentially ...
  2. Next Generation Fixed Income (NGFI) Manager

    A Next Generation Fixed Income (NGFI) manager is a fixed income ...
  3. Next Generation Fixed Income (NGFI)

    Next generation fixed income is an innovative approach to investing ...
  4. Class 3-6 Bonds

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

  6. Promotional CD rate (Bonus CD rate)

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

You May Also Like

Related Articles
  1. Retirement

    How do deferred tax assets help in meeting ...

  2. Mutual Funds & ETFs

    ETF Analysis: Vanguard Total Bond Market

  3. Bonds & Fixed Income

    Dodd-Frank Creates a Liquidity Crunch ...

  4. Fundamental Analysis

    20-Year Treasury Bond ETF Trading Strategies

  5. Mutual Funds & ETFs

    ETF Analysis: Direxion Daily 20 Year ...

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!