People who are interested in investing should be familiar with both stocks and bonds to some extent. After all, stocks and bonds are some of the most often-cited investments out there, not least because the two are used as comparisons for one another. Generally speaking, stocks are cited as an example of more risky investments, whereas bonds are cited as an example of less risky investments. However, it is important to note that these are generalizations that leave out a lot of the nuance that can exist for both kinds of investments. Something that interested individuals should watch out for.
What Is a Stock?
If pressed, there are a lot of people out there who would respond that a stock represents partial ownership in a corporation. However, the truth of things is more complicated than that, as shown by the fact that corporations are treated as legal persons. As a result, corporations are the ones that own their own possessions, not their shareholders. For that matter, said definition would exclude preferred shares, which entitle their shareholders to guaranteed dividends but none of the rights that most people would associate with ownership.
Instead, it might be more accurate to say that a stock is an investment representing the fact that the shareholder is entitled to a share of the issuing corporation’s profits. Sometimes, this share of the profits is paid out to the shareholder in the form of dividends. Other times, this share of the profits is reinvested into the corporation’s revenue-earning operations, with the result that it is reflected in its increased value. Whatever the case, it is important to note that stocks can encompass a wide range of investments because of the wide range of corporations that exist out there, meaning that there are both low-risk stocks and high-risk stocks.
What Is a Bond?
In contrast, a bond is a means for the issuer to borrow money. Essentially, the borrower promises to pay interest on the outstanding principal based on either a fixed interest rate or a variable interest rate for a fixed period of time. As a result, interested individuals tend to have a much better idea of what they can get from a bond than from a stock, though it is important to note that bonds are not without risk. After all, some bonds pay interest based on a variable interest rate. Furthermore, it should be mentioned that a wide range of entities can issue bonds, meaning that some bonds come with much more risk than others. This can be seen in how bonds issued by the U.S. federal government are considered to be either risk-free or the next bet thing to risk-free, whereas other bonds are no such thing because they come from much more uncertain sources.
What Are the Differences Between Stocks and Bonds?
Based on this, it is clear that there are some significant differences between stocks and bonds, though interested individuals might want to be careful about drawing strong conclusions based on these generalizations when comparing specific stocks and bonds. After all, there is a fair amount of variation in both stocks and bonds, which is perhaps unsurprising considering that both are wide-encompassing categories of investments in nature.
First, stocks have strong connotations of ownership, though it should be mentioned that preferred stock exchanges what most people would see as the rights of ownership for guaranteed dividends. Meanwhile, bonds are a form of long-term debt but nothing more than that.
Second, stocks tend to have uncertain returns. For example, shareholders don’t have a perfect idea of how their stock price will change. Furthermore, they don’t have a perfect idea of what dividends they will be paid even assuming that they will be paid a dividend at all unless they have preferred stock. In contrast, while a bond-holder might not necessarily get paid because the bond issuer can go under, the terms of the investment should give them a very good idea of what they can expect return-wise.
Third, stocks tend to be both higher-risk and higher-reward than bonds. This is the reason that people are often recommended to invest in a higher proportion of stocks and a lower proportion of bonds when they are young before switching over to the reverse as they age. After all, the first ratio provides a higher return in each period, while the second ratio helps investors protect their wealth as they approach the age when they will need it the most.