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Tag: difference between stocks and bonds

The Difference Between Stocks vs Bonds

To really look at the difference between stocks and bonds you have to understand the basics of each. Definitions make up our world and help us with understanding, so here we go. In common parlance, we can compare a company to a house. When a person buys a house, they have a deed, which is a legal declaration and description of the property. Stocks are like owning a portion of the deed for a company.

So, in a simple example, if a company has a book value of $100,000 and they want to sell 100 shares, the shares might be considered worth $1000 each. In exchange for the share, a shareholder, also known as stockholder, would be entitled to a share of any net profits the company makes. Using our simple example, each shareholder may get 1% of the net profit as a return on their investment. If the company makes no money, there would be no return on investment (ROI). In the event of a loss, the company might be worth only $90,000 and the shares might then sell for $900. This is an overly simplified view, but this is for illustration purposes only.

Using the same scenario, if that same company wanted to raise money, but not sell shares, they might sell bonds. Generally, a bond is considered a loan to the company. (Bonds are also issued by municipalities, from local governments to federal governments.) This loan might be that the company will sell you a $1,000 bond for $800 and the bond would be worth $1,000 when it matures (in 8 to 10 years typically.) During the maturing, the company also agrees to pay a fixed amount every six months. The fixed amount usually is tied to the current interest rates but does not have to be.

So what are the advantages and disadvantages of each of these? Unless a company goes bankrupt, you are guaranteed to have a return on investment with a bond. They are more stable, predictable and safer investments.

However, bonds aren’t usually giving you large returns. Another disadvantage is that they are not liquid, and you can pay a penalty for cashing them prior to their due date.  Stocks, on the other hand, can give you greater returns, but carry a higher risk with no guarantees. They are more liquid, so if you need to get to your money more quickly, there are no consequences like penalties, just the standard fees involved in your transaction.

In other words, a bond is like a tortoise and a stock like a hare. Remember though, sometimes it is rabbit season, and your hare may be scalped.

Normal advice given to investors is to have more money in the higher risk stocks while you are younger and to gradually shift to the more conservative bonds as you get closer to retirement.