In the past few years, the number of people who invest in securities has increased many times. As you might already know, the most traded investment assets are stocks and bonds.
Of course, both securities have different advantages as well as disadvantages.
Also, they can be purchased on different platforms or through a variety of markets. However, unless you are an experienced investor, then you might be wondering what the difference between stocks and bonds is.
Well, the good news is that you have come to the right place. This article will explain the difference between these two tradable investment assets, which security is safer than the other, as well as which one outperforms the other.
Understanding how stocks and bonds work could help you become a better investor. So, let’s take a look at what stocks and bonds are.
Stocks and Stock Investing
Simply put, stocks are shares, known as an equity investment. They represent part ownership in the form of shares in a publicly-traded company. Due to the partial ownership rights in the company, investors earn when the company is performing well.
Moreover, these earnings may be paid out in the form of dividends. On the other hand, some companies prefer to retain a part of the profits. Typically, when companies do so, they may use the retained earnings to expand operations or for making strategic acquisitions. Thus, promising even higher future earnings.
Typically, investors prefer stocks for their long-term success potential. If a company performs well, then it’s making a profit. By owning shares in the company, you participate in this success.
Furthermore, the stock price is determined by many factors. For instance, the price is dependent on the company. On the other hand, the company is dependent on its environment – customer base, industry, the general economy, political climate.
It is essential to note the difference between investing and speculating. If the company isn’t making a profit and you end up buying stocks, then you are speculating.
Of course, before investing in any stock, you need to ask yourself the following questions:
- Why do I want to invest in this particular stock?
- Do I have enough funds if something goes wrong?
- Did I do a good enough study on the company?
Experienced investors know how essential the last one is. Remember, you should always research the company you want to buy stocks from. And you have to do it before you invest in the company.
You have to look at the company’s main financial statements – income statement, balance sheet, the company’s annual report, as well as reputable stock investing newspapers and websites.
Here’s a list of reputable financial websites
- Financial Sense
- The U.S. Securities and Exchange Commission
- Yahoo! Finance
Furthermore, the Earnings, Equity, and Sales numbers should be higher than the year before. On the contrary, the Debt number should be lower than the year before and lower than the company’s assets.
Advantages of Investing in Stocks
- An equity instrument carrying ownership interest
- High return potential
- An ownership stake in the company
- Some companies pay dividends to investors
- Voting rights in the company
Disadvantages of Investing in Stocks
- No return of capital is guaranteed
- High risk
- No guarantee of dividend payment
- Stock market volatility
- Liquidity risk
Bonds and Bonds Investing
In short, bonds are fixed-income loans in the form of security. And, typically, they guarantee a fixed return. Also, at some point in the future, the loan amount will be repaid.
Further, the issuer of the bond is the borrower, and investors, which are called bondholders, are the lenders. Moreover, bonds pay a predetermined interest rate, the coupon, at predetermined intervals to repay the principal on the maturing date, ending the loan. Usually, the coupon is paid annually.
In other words, bonds are securities which obligate the issuer to make specified interest and principal payments to the holder on specified dates. Although the issuer of the bond will pay the interest every period, none of the principal will be repaid until the end of the loan.
Typically, bonds are issued by corporations or governments. As such, they are considered safer investments than stocks. There are different types of bonds to fit different needs of investors – Corporate, Treasury, Agency GSE, Municipal, etc. Furthermore, in some countries, bondholders are protected by the law. For instance, if a company goes bankrupt, bondholders may receive money back.
Also, statistics show that bonds are less volatile than stocks. Not only this but sometimes the bond interest payments are higher than the general level of dividend payments. In addition, bond prices tend to rise when rates fall, and vice versa. If rates rise, then the bond prices fall.
Advantages of Investing in Bonds
- Return guarantee
- Interest return
- Additional benefits preferential treatment when the bond matures
- Interest repayments and principal at maturity
- Less volatile compared to stocks
- Safer investment than stocks
- Profit if you resell the bond at a higher price
Disadvantages of Investing in Bonds
- Interest rate risk
- Prepayment risk
- Credit risk
- Reinvestment risk
- Liquidity risk
- Maker volatility
- Lower returns than stocks
- Bond yields can fall
- Companies can default on your bonds
The Difference Between Stocks and Bonds
Generally, stocks are shares in the ownership of a company or business. Moreover, shareholders are rewarded with dividends. On the other hand, bonds are a form of debt with a promise to pay back the money with interest. Bondholders receive periodic interest payments. Of course, these two tradable instruments have their differences.
Stocks are a riskier investment than bonds when it comes to the repayment priority. For example, shareholders have the last claim on any residual cash in the event of the liquidation of a business. On the other hand, bondholders may have a considerably higher priority.
Stockholders have voting rights. When company issues are concerned and discussed, the holders of stocks can vote, whereas bondholders have no voting rights.
Bonds are less volatile because bonds pay a fixed rate of return. Thus, many investors consider bonds to be a safer investment than stocks. However, several factors influence the volatility, such as expected inflation, discount rates, and present value.
Some bonds have conversion features depending on the terms of the bonds. In other words, they allow bondholders to convert their bonds into company stocks. Experienced investors know how useful this option is, especially when the price of the company’s stock rises.
By converting the bonds into company stocks, bondholders can enjoy the perks of capital gain. Also, as we mentioned earlier, by doing so, the bondholder will now have voting rights on specific company issues.
Stocks provide greater return potential = greater volatility = greater risk
Bonds are liquid and easier to resell.
All tradable investment assets have a monetary value. But between stocks and bonds, which one performs better? Well, historically speaking, since 1926, stocks have produced higher returns than bonds.
- Timeframe: 1926 to 2017
- The average return for stocks: 10 %
- The average return for bonds: 5 – 6 %
As the data show, stocks are more profitable than bonds. So, if you want to grow your finances over the long-term, then placing your funds in the stock market gives you this opportunity.
Do you want to invest your money in stocks or bonds? Have you got your money together? If you have, then you are probably already on the next level – which securities should you buy.
However, the essential question is, which is the better investment option for you? After reading this article, you should already have a basic knowledge about the differences, advantages, and disadvantages of stocks and bonds.
The information here can help you make the right choice or at least steer you in the right direction. You must decide what type of investor you are. It is also of the utmost importance that you diversify.
When investing, the goal is to build a portfolio of diversified holdings. Basically, the more securities an investor has, the more diversified portfolio the investor owns. Typically, diversification means spreading your portfolio across several asset classes.
This way, you reduce the risk and volatility in your portfolio over time. However, you should know that diversification does not guarantee a profit or against loss.
Furthermore, when investing in stocks and bonds, surprises are inevitable. Keeping up with your portfolio, the financial markets, and the general economy on a daily basis will prevent you from worrying.