Difference Between Stocks And Bonds

Many people don’t understand the differences between stocks and bonds. It occurred to me recently that even those who invest in these types of securities through either personal investment accounts or retirement plans can’t really articulate what the differences are. Bonds and stocks are both securities, but the major difference between the two is that (capital) stockholders have an equity stake in the company (i.e., they are owners), whereas bondholders have a creditor stake in the company (i.e., they are lenders). Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely. An exception is a consol bond, which is a perpetuity (i.e., bond with no maturity).

Stocks represent partial ownership of a corporation. If the corporation does well, its value increases, and you share in the appreciation. However, if the corporation goes bankrupt, you can lose your entire initial investment. Bonds represent a loan you make to a corporation or government. For example, you can buy a US Treasury bond for $100, and get a guaranteed 4.75% interest rate for 5-years, and can expect to get your $100 back at the end of that 5-years. Your risk is repayment of the principal (amount invested). According to Stock Tips do not rely in your own understanding of the market. Two pairs of eyes are always better than ones.

When deciding whether to invest in stocks or bonds, the risks versus the potentials have to be weighed. Stocks have much greater potential to increase in value but they are also more subject to market fluctuations. Investment grade bonds (those with a rating of BBB or better) carry less risk but offer a relatively low yield. Bonds always carry the risk that the principal amount may not be paid back. Companies with higher credit worthiness are more likely to be safe investments but their coupon rate will be lower than companies with lower credit ratings. Credit ratings are provided by firms such as Standard and Poor and Moody's Investor Service. Credit ratings range from a high AAA to a low D.