Stocks and bonds are the two most popular investments options, though they are different with respect to form, purpose, as well as risk. It is essential for any investor making a decision on a balanced portfolio to know what makes stocks and bonds different.
Definition and Ownership
The primary difference between stocks and bonds lies in what they represent. A stock represents ownership in a company. When investors purchase stocks, they are buying part of the company and therefore their claim on a portion of its assets and earnings. Stocks usually are bought with expectations that the firm might grow; hence the value of its shares may increase and potentially give dividends.
A bond is essentially a loan given by the investor to the issuer, and an issuer can be either a corporation, a government, or a municipality. An investor purchases a bond in order to lend money to an issuing entity in the form of periodic interest payments. Upon maturity the end of the life of the bond, the issuer is required to repay the principal amount.
The differences between stocks and bonds may be summarized in the table below
|
Stocks |
Bonds |
|
|
Definition |
Represents ownership in a company |
Represents a loan made by an investor to an entity (corporate or government) |
|
Ownership |
Shareholders have an ownership or share in the company. |
The bondholders are creditors of the company, not owners. |
|
Returns |
They receive dividends and capital appreciation. |
They receive interest payments and return of principal. |
|
Risk level |
Higher risk, as the values change based on what companies or businesses and the market situation are doing. |
Lower risk, at least in the case of government bonds, although that again is dependent on the creditworthiness of the issuer of the bond center. |
|
Priority in Bankruptcy |
Last to be paid or called on for assets; this occurs after money paid out to the bondholders. |
Higher than shareholders because it gets repaid first in case of bankruptcy. |
|
Volatility |
Generally, more volatile |
Less volatile than stocks |
|
Type of Income |
Variable (depending on the firm’s performance and market conditions) |
Depending on the type, fixed or variable interest payments as determined in bond terms. |
|
Investment Horizon |
Generally, fits better for long-term growth |
Short and long term; may depend on maturity date |
|
Voting Rights |
Stockholders often have voting rights |
Bondholders have no voting rights |
|
Types |
Common and preferred stocks |
Government, municipal, corporate bonds |
|
Tax implication |
Dividend and Capital Gains Taxability |
Interest Income is generally taxable, although some municipal bonds are tax free |
|
Market Value Fluctuation |
Highly Influenced by Market Movements and Company’s Performance. |
It is sensitive to fluctuations in interest rates and changes in credit rating. |
|
Liquidity |
Very liquid, especially for large cap stocks. |
Varies; government bonds are very liquid but some corporate bonds are less liquid than others. |
|
Objective |
To enjoy generating capital growth |
Income generation and capital preservation. |
Summary
Stocks and bonds serve entirely different purposes in a portfolio. Stocks give ownership and, of course, the possibility of high rewards, but such rewards come with higher degrees of risk and volatility. One means of striking a balance between the need to take some risk for reward is to combine stocks and bonds the best way investors have to balance their needs for rewards relative to their financial goals and time horizon.