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Investing for a Lifetime: Managing Wealth for the "New Normal" by Richard C. Marston

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CHAPTER 2 The Building Blocks of a Portfolio: Bonds and Stocks

Investors can invest in a variety of assets from bank deposits to real estate. But it’s best to begin a discussion of investment returns by studying two basic assets: stocks and bonds. These are the two fundamental assets in any economy. Bonds promise a steady stream of coupons (at least in nominal terms). Stocks offer dividends, but provide investors with upside potential from capital gains. We will discuss a wider array of assets later in the book, but many of them are highly correlated with U.S. stocks and bonds.

In this chapter, only one type of bond will be considered: the U.S. Treasury bond. By studying Treasury bonds, we can ignore the default risks associated with private sector bonds such as corporate bonds or mortgage-backed bonds. Treasury bonds are not without risk, but these risks stem from the volatility of bond prices and the eroding effects of inflation. We will discuss these risks later. A series for the 20-year U.S. Treasury bond extends all the way back to 1926, so this bond will be analyzed in detail.

Similarly, only one series for stocks will be considered, the S&P 500 stock index. This is a series for large capitalization stocks also extending back to 1926. Investors are often interested in a wider variety of stocks. Indeed, we will have chapters ahead to discuss other types of U.S. stocks as well as foreign stocks. But the S&P is often used to represent the overall U.S. stock market. The S&P ...

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