Are Bonds Really Safer Than Stock Investment?

Just like any other investment, you must be make sound decisions based on the information you have, in order to make the best out of whatever investment option you choose.

There is a widely pronounced notion that debts or bonds are safer investment securities than equity investment and the reasons for this are not far-fetched. First, debt securities have a superior claim on cash flows. The interest accrued must be paid or else the bond holders would have a claim of assets even in the cases of bankruptcy or asset liquidation.

They pay investors a regular fixed income that has been predetermined, the prices are not as volatile as stocks because bond prices fluctuate less than stock prices, and they offer essentially two ways to earn money which are from interest income and from capital gains. (You can collect interest on your bonds and also sell it at a higher price before their maturity.)

All these advantages of bonds are what constitute the very disadvantages of stock investments. From the zero guaranteed return, possibility of little or no dividends, and even a total loss of investment capital.

Stocks might offer investors a stake in the company, but there’s really no guarantee that they would get paid – this is the general idea.

The limitations of bonds in comparison to stocks are also profound. The heightened assurance that bonds have, leaves them with limited returns. Sometimes, the interest rates are just barely above inflation levels.

And with bonds, there is really no hope to earn more even when the company performs extraordinarily well, it is almost as if you didn’t invest in the first place. This is because the investor will never earn more income than what was contractually promised in the bond.

However, in comparing riskiness between bonds and stocks, there is more than meets the eye. For one, many of us are guilty of assuming risk and volatility mean the same thing. Volatility refers to the fluctuations in the price/ value of a security.

Risk on the other hand is tied directly to a loss in value. In other words, a stock might move as much as it possibly can, but still earn you immense profits when it is time to cash out.

The value of a bond can still go all the way to zero and even though it might not be as common, there are situations where after liquidation, the company still cannot afford to pay the bondholders and they ultimately lose their principal investments.

In other words, the bond is in a precarious position as while its upside is fixed and inherently limited, it can also fail altogether. But that’s not all.

In periods of rising inflation, the price of bonds can be wrecked as well. The value and interest on bonds are predetermined and if inflation rises high enough, the Naira value of your bond investment is now much less valuable.

This makes it way much cheaper for companies to pay at much cheaper rates. However, in this situation, companies might be able to increase their share prices, increasing the value of the stock and this can even be higher than the prevailing rate of inflation.

What this means is that the stock investor is not just be covered, but can also shift with the inflation to make profits.

The above scenarios show that it is not enough to generally assume that bonds are safer than stocks. The context matters.

What is the present environment like? What is the duration of the period? What are the chances of default? Bonds might have their advantages, but they have their risks as well.

Just like any other investment, you must be make sound decisions based on the information you have, in order to make the best out of whatever investment option you choose.

Written by Lawretta Egba.