Learn The Stock Market Lesson - Stocks VS. Bonds! Which one should YOU choose?
Stocks are equity investments. What does equity mean? Equity is a term that simply means ownership or having a stake in something. Therefore, this would mean that one share of a stock would give you ownership in the corporation that issued that stock. You now own a percentage of that company.
Bonds, also known as fixed income investments or debt securities, are a form of debt in which an investor loans money to an entity, such as corporate or governmental. A bond is like an “IOU” (I owe you) from the issuer (borrower) to the bondholder (lender), which indicates that the issuer will repay the bondholder over time for the loan, with a fixed interest rate. Unlike stocks, bonds are not only issued by corporations, as they are also issued by the federal government, state government, and municipal government. In summary, bonds allow people to invest their money as a loan to an entity in return for a stable rate of interest. The main categories of bonds are corporate bonds, municipal bonds (which are issued by cities), and U.S. Treasury bonds, notes and bills. Simply think of bonds as loans.
Another difference between stocks and bonds is that the owner of a corporate bond is among the first to receive any assets (their investment) from the dissolution of a company, should the company go bankrupt. In this sense, bonds are safer investments than stocks, particularly common stocks (as mentioned in my previous blog that common stock holders have last priority). Meanwhile, this also means that bonds do not receive a share in the wealth generated by a fast-growing company. Safer investments mean less risk, which means their potential of receiving high profits are lower compared to investments that are riskier. In other words, investments with higher risk have the potential for greater rewards. Why else would anyone take on risky investments, right?
So, now that you know the differences, which one should YOU choose? This is where the issue of risk VS. reward comes into battle. Do you to be a bondholder and have a better chance of getting a piece of your investment back if a company goes bankrupt? (Common stockholders usually lose their entire investment after the company pays back all their creditors, which includes bondholders and preferred stockholders.) OR are you willing to take on that risk in hopes of receiving high profits and nice rewards?