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What is the difference between stocks and bonds?

Here I’ll briefly summarised from The difference between stocks and bonds explained.

If you choose to invest in a company, there are two routes available to you:

  • Equity (also known as stocks or shares)
  • Debt (also known as bonds)

Shares are:

  • issued by firms
  • priced daily
  • listed on a stock exchange

Bonds are:

  • effectively loans, where the investor is the creditor
  • in return for lending money to issuer, the investor receives an annual income as well as the ultimate repayment of principal amount (unless issuer defaults or the bond is purchased at premium)
  • can be issued by both companies and governments
Image courtesy of Fidelity International.

What are the differences?

1. Shareholders versus bondholders rights.

When investors buy shares in a company:

  • they become one of many co-owners
    • significant shareholders can shape company’s strategy
    • right to veto and veto corporate proposals
  • Upside: share price can rise in value, allowing investors to sell their holding and make a profit.
    • Companies can also share their profits via dividend payments to shareholders
  • Downside: shareholders are not promised any economic returns.
    • Share prices can fall significantly; shareholders may have to sell at a loss or wait and hope the shares recober
    • Company can go into liquidation; shareholders are the last to be repaid.

Bondholders are in a more secure position if the company comes under bankruptcy. They fall under the category of creditors, and therefore are repaid before shareholders.

2. What about risk?

General rule of thumb in investing: the riskier the investment is, the higher the potential to make a gain, but the chance to make a loss is also higher.

  • Shares are generally deemed riskier than bonds.
  • Some bonds, issued by high-risk companies and governments, can be just as volatile as some shares. (Termed as high yield bonds.)
3. Complementary assets

Bonds and shares can work well together as part of a well-diversified portfolio. They tend to have low correlations with each other, meaning they respond differently to changes in the economic cycle.

If an economy is shrinking during a recession, interest rates are often cut, which tends to mean higher bond prices (and lower yields). This is a particularly good environment to invest in bonds.

Choosing the right investment

Before investing in either bonds or shares, it is important to ascertain your tolerance of risk. Do not invest what you cannot afford to lose, and it is a good idea to consult a professional financial adviser for guidance. And whatever your choice, it is worth considering a mutual fund where your investment is pooled with other people’s and invested in a wide range of assets. That means the effect of a default (in a bond fund) or share price fall (in an equity fund) is minimised.

The difference between stocks and bonds explained, Fidelity International

Read full article: The difference between stocks and bonds explained


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