5 Differences Between Stocks And Bonds: A Beginners Guide
One place every new investor starts at is the pick between stocks and bonds. Both are very different, with unique earning opportunities and risks.
First up, lets clarify one thing:
What is the difference between stocks and shares?
A company has stock on the stock market. You buy shares of that stock. The more shares you have in that stock, the more ownership of that company you have.
So any stocks vs shares discussions aren’t relevant.
Another question you may have is:
Should I invest in lots of stocks or just one?
When investing, you want to diversify in a number of stocks across different sectors. Experts say that diversifying is a smart move because if one sector is taking a hit, all of your eggs aren’t in one basket.
So now we’ve got the fundamentals, lets dig into the big investment question, stocks or bonds?
The 5 key differences between stocks and bonds?
|#1.||Represents ownership interest in a company.||An instrument of debt, where a company or institution can sell debt with a future promise to repay.|
|#2.||Offers a high risk, big reward trading opportunity as there are no guarantees.||Offers a lower risk investment opportunity as bondholders are given priority of repayments.|
|#3.||Stockholders are considered company owners.||Bondholders are considered a company’s or institution’s lenders.|
|#4.||Stocks have earned around 10-percent yearly since 1929.||Bonds have earned around 6-percent yearly since 1929.|
|#5.||Some stocks pay out dividends when the company makes a profit.||Interest payments are made to bondholders over a fixed schedule.|
What are stocks?
When you buy stock, you are buying a fragment of the company. This is the primary reason to issue stock via an IPO, so that a company can raise money to expand the business.
- A stock can be preferred or common. The key differences between the two are:
- Preferred stockholders have no voting rights in the company.
- Common stockholders are last in line when it comes to assets. With creditors, bondholders, and preferred stockholders coming first.
- Both of the above represent a portion of ownership (or equity) in a company.
- A company’s stock has a unique ID and a valuation that changes based on news, events, and quarterly company results.
As stock value can rise and fall, being a stockholder (or shareholder) can have great highs, and horrible lows. Plus, if you’re looking for stocks that pay out dividends check out these five stocks below:
- Skyworks Solutions, Inc. (SWKS)
- Broadcom Inc. (AVGO)
- The Home Depot, Inc. (HD)
- Lowe’s Companies, Inc. (LOW)
- Garmin Ltd. (GRMN)
What are bonds?
When you buy bonds, you are buying up debt a company or institute has specifically created so that they can raise capital, just like a stock IPO. A bond could be best described as a loan you have given the company or institution.
- The reason a high-quality bond is considered a lower-risk investment than stock is that each bond is a promise from the company to repay that initial investment back, plus scheduled interest.
- Bonds have a set period where interest is paid to the bondholder:
- This can be a few days to 30-years.
- Once that period is complete, the bond’s value is paid to the bondholder in full, this is known as holding until maturity.
- A bond is not risk-free. If the company goes bankrupt the scheduled interest payments will end and you may not get your initial investment back.
One way bonds do not generate income for investors is through dividends. So despite the value of the bond increasing over time, until it matures it is only generating recurring interest for an investor.
Bonds vs stocks
The main considerations when looking at bonds and stocks are:
- Stocks: To make a profit (capital gain) from the stock market you need to buy low and sell high. You can also ride stocks for dividends but not all stocks offer this.
- Bonds: To make a profit from bonds you need to be patient and pick the right bonds:
- Treasury bonds: Interest is paid every six months until maturity.
- Treasury bills: Interest and bond are paid on maturity.
- Corporate bonds: Interest can be paid monthly, quarterly, twice-per-year, or at maturity.
- Risk: Both stocks and bonds have risks but bonds are generally safer. Especially if investing in U.S. Treasury bonds which are backed by the government. With less risk, however, there is less annual return. For example, if your portfolio is 100-percent filled with bonds, the average annual return over the last 93 years is 5.3-percent. Whereas if your portfolio was 100-percent stocks, the average annual return over the last 93 years would have been 10.1-percent.
Bonds are a slow burning investment for the person who wants to make their money work, with less risk. No investment is 100-percent risk-free but in comparison to the stock market, bonds offer some safety and potential for a recurring income.
On the flip side, if you like big rewards the stock market is the best option. You can explore stocks that pay dividends for periodic earnings but the key is to buy low and sell high for capital gains.
Be warned, investing in stocks and bonds has risk. Always do your due diligence on the company or institute you’re investing in.