Difference Between Stocks and Bonds
Many people often wonder: “What is the difference between stocks and bonds?” Well, if you are an ardent follower of the stock exchange market, there are two terms that are recurring within that business ecosystem. It doesn’t matter if it is the New York Stock Exchange or the London Stock exchange, these terms are stocks and bonds. The truth is, if you don’t know the difference between stocks and bonds, you will find it pretty difficult to comprehend a lot of things that are part of the stock exchanges area around the world. Interestingly enough, if you are perusing this guide because you are weighing your options, it is a smart decision. This is particularly true because it’s not advisable investing in an industry that you know next to nothing about.
Without mincing words, that industry contributes significantly to the economy of any country. In other words, if you don’t know the differences between stocks and bonds, you apparently have no idea about how the economy of a country works. Whatever the case, you have nothing to worry about as the difference between stocks and bonds will be fully discussed in this well-researched guide. In accordance with our usual tradition, we will start by defining the terminologies, then contrast them in a table and finally come to a conclusion.
Definition of Stocks
Simply put, these are stakes in the ownership of a company. Basically, it is a marketable investment with a variable monetary value. Also, it’s one of the most widely traded items on the floor of many exchanges around the world. Stock, equities and shares have a lot in common. The similarity is that they are traded in a public liability company (PLC). As a result, many people use them as synonyms. In addition, you can also think of them as the money (loan) that people have lent to a company or a government to run an organization, which automatically makes them partial owners of the company or government’s organization. This simply means that it can be bought and sold. Another concept that comes up a lot in this industry is that of the market. Well, this is the platform where investors trade stocks as equities.
The most common traded in the market are options and futures. Equity holders are said to be people who have purchased stakes in certain companies. So, the market serves as the platform where traders meet. Keep in mind that the platform is regulated, controlled and fair, which allows everyone to be on an equal footing. It is said that a country’s economy prospers when this trading platform is stable and healthy.
Well, the market is divided into two, the primary market and the secondary market. The primary market is the platform where new entrants launch their IPO (initial public offering) with underwriters setting the initial price. Similarly, the secondary market is the platform where most of the trades take place.
To be clear, an IPO means that a company gives a percentage of its ownership to the general public to buy it for cash. With the funds raised, the company can then invest it in other things. This means that anyone (investor) who buys the shares is automatically one of the owners of the company. Well, this type of company is known as a PLC. It doesn’t end there.
At this point, it means that investors can then trade the stock of that company on the floor of a stock exchange with other investors for the sole purpose of making a profit. Additionally, when you buy a company’s share, you automatically buy its earning and assets.
So far, we have focused on one concept. The reasoning behind this is to make the stocks and bonds difference easy for you to understand. Again, what’s the difference between stocks and bonds? Just before we give an thorough explanation of the disparity between the trading alternatives, we will put the meaning of bonds into perspective.
Definition of Bonds
This, on the other hand, is a fixed-income loan that investors make to an organization or the government. It can also be bought and traded. To buy or sell them, an investor will have to go to the bond market. Feel free to say that the market is a platform where investors go to trade debt securities. These securities come in different forms.
Essentially, when you get involved in this market, it is similar to a commercial bank that provides credit facilities to individuals and organizations to use (the loan) for projects or business growth. In other words, you lend money to certain organizations under certain conditions. In this context, conditions are the length of time the organization will repay your money and must pay the accrued interests. This is exactly what commercial banks do. Going further, they say that bondholders lend money in the hope of getting interests.
Just before we get into the difference between stock and bond, you should know a little more about the bond market. Well, this is a platform that provides all investors with a regular source of income. Often, holders of these securities may not want to trade them at the same time. They will prefer to maintain them in their portfolios for future use. For instance, there have been cases where they have been earmarked for retirement, children’s education and other futuristic purposes.
The first step in investing in this line of business is to get more information about the bond you wish to acquire. There are many online sources that provide reliable information about them. These online sources provide up-to-date market information. For instance, they provide investors with information on analysis, news, data and research.
You can also get the information from brokerage accounts. The players in this market include issuers, underwriters and participants. They are usually rated by a rating agency, which informs investors of the risks associated with them. For instance, a bond rated “AAA” is of high quality, while one rated “BBB” is of medium risk. These ratings help investors to make informed decision.
To invest in this line of business, the first step is getting more information about it. Truly, there are many online sources that give reliable information about them. These online sources provide up-to-date market gist. For instance, they give investors information about analysis, news, data and research. You can also get the information from their brokerage accounts.
So far, we have provided detailed explanations on the definition of a bond and its market. Well, we will now answer the question: “What best describes the difference between stocks and bonds?”
Stocks vs Bonds Comparison Table
The table below deals satisfactorily with the difference between bonds and stocks. So, get ready to go through them.
|Basis for Comparison||Stocks||Bonds|
|Meaning||These are stakes in the ownership of a company. They can also be called shares or equities.||These are debts payable by a company or government to investors because they owe these investors. They are always created when the company or government wants to finance a project.|
|Risk||Given the amount of money that an investor can lose overnight, stocks have more risks.||The risks associated with bonds are minimal.|
|Market||These are bought and sold on the floor of market exchanges. This means that they have central point for buying and selling them. For instance, the New York Stock Exchange.||Basically, these are sold over the counter (OTC), so there is no central point for buying and selling them.|
|Profitability||History has shown that investors in stock are by far more likely to make more profit over a long period of time. This is often the case when a company’s stock keeps soaring.||While there are lots of profits that investors stand to get from investing in bond, in the long term, it is nothing compared to what they get from investing in the other one.|
|Profit stability||The profit made from this option can change based on the prevailing market situation.||This works with percentage coupons and doesn’t rely on market, so it doesn’t change.|
From the above, we have been able to identify the difference between bond and stock, which also helps you understand the subject. Now, we will now conclude with the guide below.
Conclusion of the Main Difference Between Stocks vs Bonds
Well, there is no gain saying that this guide has satisfactory answered the question of contrast. Given that you have read so far, we can say with certainty that you can see the great disparity between the two. However, if you haven’t, just keep in mind that one difference between stocks and bonds is that the former are shares while the latter are debts, depending on whose point of view. To conclude this article, we will look at the pros and cons of the two alternatives.
- For many experts around the world, the major benefit of investing in stock is that it tends to produce more benefits over a long period of time. However, no company guarantees its investors that they will make huge profits because the market is very unstable.
- As far as demerit is concerned, its main disadvantage is the one we have already mentioned: that’s, there’s no guarantee of returns. Investors are expected to do some due diligence before investing their money in companies’ equities. Even if companies don’t guarantee investors interests, they work around the clock to ensure that their shares stay profitable.
How about bonds? Well, we will highlight its major pros and cons as well:
- The benefit of this option is that it has low risks as it has fixed rates – perhaps it is also known as a fixed-income investment. This means that when the economy recovers, it remains fairly stable. Consequently, many investors are likely to choose this option because it offers a reasonable degree of stability.
- On the other hand, the disadvantage associated with this is that there is no high earning potential – people don’t become millionaires overnight because they have invested in this area. Everyone knows what they will earn.
Another difference between a stock and a bond is the method used to determine an investor’s interest. Not sure what we mean? Now, let’s roll up our sleeves and show you the practical application.
Here’s how it is calculated…
A company can sell 20,000 shares, and you decide to buy 500 shares. To determine how much equity you own in the company, you simply calculate: 500/2000 x 100% = 2.5%. This means that you own only 2.5% of the company’s equity. But then, the price of shares keeps fluctuating, meaning that it can go down or up sharply. Let’s say you bought your shares at $100 a share when the company went public. Then you want to sell your shares at a later date. Then you realize that the price of the shares has collapsed and is now selling at $70 a share. This simply means that your profit is: Selling Price – Cost Price. This means $(70-100) = -$30. Actually, you didn’t gain anything since you suffered a loss of -$30 for each share sold. Since you are at a loss, you cannot sell all 500 shares.
But how do stocks and bonds differ? We will clarify that now…
Let’s say that you have a fixed coupon that is set at 5% for $20,000 per value. This means that this rate remains the same for a long period of time. Based on this rate, you are entitled to:
5/100 x 20,000 = $1,000 interest as a bondholder. Even if the interest rate for the same company goes up or down, yours is already set at 5%, meaning that it doesn’t change. Overall, they are expressed as a percentage of the investment and remain unchanged regardless of what happens to the company.
To conclude this guide on stocks and bonds difference, it’s critical that we focus on risk. For many businessmen, risks is everything. While some investors may be tempted to focus on the interests they are likely to earn, they must bear in mind that equities carry lots of risks. This is particularly true because the market, like all other markets, is very unstable. In closing, please note that the aim of this article is to help you identify the disparity between the two concepts and not to give you some expert advice. Therefore, your best bet is to consult an expert for investment advice before making your final decision.