The Differences between Stocks and Bonds

Investors buy stocks to acquire a partial ownership in a particular company and buy bonds to make a loan to corporations or governments. While stockholders benefit from the company profits, the bondholders receive returns. A fixed rated return is a percentage of the bond’s original offering price. The return is called a “coupon rate.” The principal amount of bonds is returned during the maturity date. Because they can be issued for any period of time, there are some bonds which take about 30 years to mature.

The risk of not being paid back with the principal amount is always carried by bonds. Although companies with higher credit worthiness are more likely to be safe investments, their coupon rates will be lower than those companies with lower credit ratings. Firms such as Standard and Poor and Moody’s Investor Service provide such credit ratings that range from a high AAA to a low D.

The safest type of bonds is the US Government bonds. Blue chip corporations, which are companies with established performance records for over several decades, are also considered to be safe bond investments. Although smaller corporations carry greater risks of defaulting bonds, bondholders of smaller corporations are considered to be preferential creditors because they will be compensated before stockholders in case the business goes bankrupt.

Bonds, just like stocks, can be bought and sold on the open market. The fluctuation of their values is based on the level of interest rates in the general economy. For example, an investor who holds a $1000 bond that pays 5% per year in interest is capable of selling the bond at a price that is higher than the face value as long as the interest rates are below 5%. If the interest rates rise above 5%, the bond can still be sold but it is usually at a price that is less than the face value. Because the potential buyers are capable of getting a higher interest rate than what the bond pays, the seller has to sell at a lower cost in order to offset the difference of the bond.

Most bonds are traded in the Over-the-Counter (OTC) Market that is composed of banks and security firms. Corporate bonds which are listed on stock exchanges may be bought through stock brokers. New bond issues are usually sold in $5000 increments while initial bond issues are quoted in $100 increments. A bond listed at 96 indicates a selling of $96 per $100 face value.

Stocks or Bonds

The risks and the potentials have to be weighed when deciding to invest either in stocks or bonds. Stocks carry a greater potential to increase in value but they also hold a greater vulnerability to market fluctuations. Investment grade bonds, which are rated BBB or better, carry slightly lower risks but offer relatively low yields.

A lot of investors agree that bonds offer greater security and return for short-term situations but when a time span over ten years is considered, the situation changes. The stock market has consistently outperformed bond investments by a large factor since companies tend to increase in value and any short-term fluctuations in the stock market are smoothed out over time.

Because they provide a stable investment that helps cushion against stock market fluctuations, bonds still have their place in most investor portfolios. A mixture of investments that includes stocks from different industries, bonds from various corporations, and other fixed-income investments is one strategic way of providing maximum growth while securing investment funds for the future.

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