Stocks and Bonds: Essential Differences

Stocks and Bonds

The terminology used in the financial markets is puzzling. Whenever you read an article or news from the market, you inevitably meet a host of unclear concepts which you need to check in a glossary lest you misunderstand the given information. The problem with baffling terminology becomes even more critical when you want to buy stocks or other assets. If you do not have a clear idea of how stocks differ from cryptocurrencies or whether stocks or bonds bring larger returns on investments, you will not make an informed, potentially profitable decision. In investing, understanding the fundamental of the financial market is half the battle won. To help you succeed, we are explaining how stocks differ from bonds. After reading the paragraphs below, you will have a clear vision of what investment you want to make.

Stocks vs Bonds: Definition

If you want to choose the right type of investment, knowing the basic similarities and dissimilarities between stocks and bonds is crucial. Stocks or, as they are officially called, common shares, are equity ownership in a company. Investors who own common shares become owners of the business, depending on how many shares they own. For example, after Elon Musk had taken a 9.2% stake in Twitter, he became the social media company’s largest shareholder. Warren Buffet began buying Apple stock in 2016 and by mid-2018, his Berkshire Hathaway accumulated 5% ownership of the iPhone maker. Although Buffet’s profit from his investment in Apple is substantial, his influence on the company’s decisions is less strong than that of Musk on Twitter merely because their ownership in the respected companies is unequal.

Bonds represent debt that a company has issued. There are no ownership rights granted to debtholders. Individual companies can issue bonds, and so can Federal, State, and Municipal governments. When you buy a bond, a company or government promises to be in debt to you and pay you interest on the loan for a set period. After a specific deadline, it will pay back the full amount spent by you on the bond. Note that bonds might be risky. If the company whose bonds you own goes bankrupt during the bond period, you will not receive interest payments. Nor will you get back the money with which you bought its bonds. Still, in general, bonds come with a higher guarantee of repayment than capital investments.

Stocks vs Bonds: Returns

Stocks and bonds generate returns differently. Stock returns are driven by increases in a company’s share price. The higher the price of a stock jumps, the richer shareholders become. Thus, if you had invested in Tesla in 2019 when the stock was worth just over $400 a share, you would have nearly doubled your money today, when the stock costs $757.04. Companies also generate returns through the payments of dividends, which is the return of their profits to shareholders. In 2021, Apple paid its shareholders $0.87 per share, which was a drastic decrease compared to the previous year.

When investors purchase bonds, they receive interest from the company. These payments are referred to as coupons. The coupon rate of a bond is determined when the bond is being issued. The determined rate usually does not change, except when there is a floating rate bond. Corporate bonds, which are riskier than government-backed bonds, offer higher rates of return. Note that there are so-called zero-coupon bonds. These bonds do not pay interest over time but are sold at a large discount.

Stock vs Bonds: Bankruptcy Rights

When a company goes bankrupt, shareholders and bondholders receive radically different treatment. In the case of insolvency, bondholders, to whom the company is indebted, receive proceeds from bankruptcy first among other people involved in the business. Shareholders come last. They will usually collect only residual value after bondholders have received full compensation.

Not all shareholders stand last in line to receive money from a bankrupted company, however. Employees, pensioners, and government agencies might be prioritized over bondholders. When these stockholders are given preference over others, bondholders might receive less money than they are entitled to, although it is never the case that they are ignored. Because the company is indebted to bondholders, they must receive some compensation.

Depending on your financial goals, you may invest either in stocks or bonds. Note, however, that stocks and bonds are traded differently. If you decide to buy stocks, you may access any of the thirteen stock exchanges in America or any international stock exchange with the help of your chosen broker. But you cannot follow these steps if you want to purchase bonds. As there is no registered exchange for trading bonds, you should buy bonds over the counter (OTC).

Remember also to conduct thorough research of the company whose stocks or bonds you intend to buy. The more extensive research you undertake, the more informed your decision will be and the more chances you will, therefore, get to reap handsome rewards from your investment.

The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.