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Comparison between Stocks and Bonds Research Team | Posted On Tuesday, April 21,2009, 07:32 PM

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Comparison between Stocks and Bonds



What are Bonds?

Bonds always carry the risk that the principal amount might not be paid back. Companies with higher credit worthiness are more likely to be safe investments although their coupon rate will be lower than companies with lower credit ratings. Credit ratings are also offered by firms such as Standard and Poor and Moody's Investor Service. Credit ratings vary from a high AAA to a low D.

What are Stocks?

While stocks give investors part ownership of a company, bonds are loans made by investors to corporations or governments. Instead of benefiting from company profits the way that stock holders do, bond holders receive a fixed rate of return, a percentage of the bond's original offering price. The return is known as the 'coupon rate'. Bonds can be issued for any period of time; some even take up to 30 years to mature.

Government bonds are well thought-out to be the safest type of bonds. Blue chip corporations (those with established performance records that span over many decades) are very safe bond investments. Smaller corporations have a bigger risk of defaulting on their bonds, but bond-holders are preferential creditors and will get compensated before stock holders in the occurrence that the business goes bankrupt.

Bonds can be traded on the open market. Their value fluctuates according to the level of interest rates in the universal economy. For an instance, if you hold a Rs10,000 bond that pays 5% per year in interest you can trade the bond at higher than face value as long as interest rates are below 5%. If they increase above 5%, your bond can still be sold but generally at less than face value. This is for the reason that investors are able to get a higher interest rate than what your bond pays so in order to offset the difference your bond has to be sold at a lower cost.

Most bonds are bought and sold in the Over-The-Counter (OTC) market which is made up of banks and security firms. Some corporate bonds are also listed on stock exchanges and may be bought through stock brokers. New issues of bonds are generally sold in Rs. 5000 increments while bonds bought and sold after the initial issues are quoted in increments of Rs. 100. A bond that is listed at 96 is selling for Rs. 96 per Rs. 100 face value for a particular share.

Stocks or Bonds:

While taking decision whether to invest in stocks vs. bonds, the risks versus the potentials have to be weighed. Stocks have much enhanced potential to increase in value although they are also more subject to market fluctuations. Investment grade bonds (those with a rating of BBB or better) carry less risk although offer a relatively low yield.

Most investors agree that for the short term, bonds present greater security and return. The situation changes, though, when time spans of longer than 10 years are considered. The stock market has always outperformed bond investments by a large factor. This is for the reason that companies continue to increase in value and any short term fluctuations in the stock market are smoothed out over time.

Bonds still have their place in most portfolios, though; they provide a stable investment which helps to moderate against stock market fluctuation. A mixture of investments including stocks from various industries, bonds and other fixed-income investments is the technique to provide maximum growth while securing your investment funds for the future.

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