The Difference Between Stocks and Bonds
Stocks essentially refer to ownership of a share of the company, usually describing a very small portion. Bonds are debt that is issued by a certain entity that has to repay it eventually.
A bond is part of a loan, but it is issued by larger entities like governments, and there is very less risk of default. Bonds are also publically traded, which means you can by the bond from others.
Corporations can also issue bonds as well. The term capital structure refers to this; the balance between stocks and bonds.
A company can raise money using either a stock or bond. They can either accept capital from bond investors and repay later, or sell shares to raise money through equity.
From an investor’s perspective, you are safer with bonds. If a company shuts down and goes out of business, the shareholders are unlikely to see any of the money. Bondholders are repaid first. Therefore, in the event of a business shutdown or an economic collapse, stocks are much riskier.
However, as you may have heard, increased risk means increased returns; in the case of shareholders. Bondholders receive intermittent interest payments, which are guaranteed structured income. Shareholders receive dividends.
These are usually guaranteed structured income. On the other hand, shareholders can receive dividends. When things are going good and a company has made high profits through the year, that doesn’t mean they will award bondholders with some bonuses. They may however, increase dividends for that year so the shareholders are happy.
Shareholders have voting rights which bondholders don’t have. They can persuade the company and make sure their interests are safeguarded.
Lastly, if the company is very valuable, the shareholder can always trade away his position. Stock prices are continually varying, which means a shareholder can make much more money for heir share than what they paid for it. Bond prices do not fluctuate in this manner.
Based on what we said above, it is obvious that stock returns are constantly changing. The annual average return is around 7% annually, and they are safe investment vehicles.
Safe bonds can give lower returns, however there is always a risk with shares due to unpredictability in the stock market.
The common factor among both is patience and longevity. Tie up your money in long term investments for the best rates.
The bottom line, therefore, is to diversify your risk and have both from different companies and different markets, so that you lower risk and maintain high returns.
You can try for index funds when you invest in the stock market to guarantee a good diversification. It will also lower the risk and it’s lengthy and difficult to pick individual stocks.
It’s actually possible in some cases that bonds can be converted into shares if this feature was agreed on before issued. This exchange typically occurs when a company’s capital structure reaches a specific ratio of bonds to stocks.
This gives bondholders a chance to eventually vote and hold ownership of a company.
The final question may be which one is best? Well that depends on what your plan is. If you want to take on more risk and have an offense type strategy, then stocks are a good option. This way you can invest in different small cap stocks, particularly from the tech sector, which have excellent potential. The companies can be risky however, as they can easily go bankrupt as they can issue a patent and reach gigantic success. Of course, you can diversify with many small investments, but it will take time to research each and there is definitely a bit of a risk with that. You may as well just follow a small-cap index fund so you can profit from the triumph of the market itself. This however will require you to have a lot of faith in the long-term, and holding out through harder times and high volatility.