I’m pretty okay at basic investing in stocks, but it’s hard for me to understand how bonds work. How do changes in interest rates (Fed rate?) affect bonds and why? Why do bonds and stocks generally have an inverse relationship?
Bonus upvotes if you also explain like I’m 21.
In: Economics
Stocks typically have higher rates of return than bonds. But bonds are much less risk. So there risk /reward trade off made by investors when they choose to invest their money. As interest rates rise, there are investors who are willing to flip from stocks to bonds based on their personal risk/reward profile. When it’s a difference of 8% with risk or 2% risk free, they take more risk. When it’s risky 8% or no risk 5%, suddenly the low risk option seems the better of the two for more investors. As more money gets invested in bonds, that money isn’t invested in stocks and creates a lower demand for stocks, lowering their return. So now stocks are only returning 7%, further narrowing the risk/reward trade off.
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