The Trade-off between Stocks and Bonds

Two main investment securities are stocks and bonds, and depending on how you choose to look at it, one could be better than the other.

Bonds are simply loans. Investors loan their monies to certain strong companies or governments of nations towards ensuring the safety of their principal amount while also guaranteeing a fixed rate of return at a specified future date.

On the other hand, stocks are investments into companies where investors become owners by virtue of the stake they have gotten there. With shares in a growing company, the value of your investments too are growing.

Much like bond holders have interests, shareholders have dividends that are paid out periodically.

When it comes to making a decision on whether to invest in bonds or stocks, there are 3 main things to consider and they include the expected rate of return, the risks, and your objective as an investor.

Bonds naturally yield much lower than stocks over time and the reason is not really farfetched. Since bonds are relatively safer than stocks, the yields are low.

Shareholders do not receive the certainty that bondholders have about when they’ll get their money and if the money will even be more or less than what was spent.

With stocks, when a company fails, the shareholders lose a portion of their investments – or even all of it.

It is pertinent to note that there are various issues that could affect the value of bonds or cause them to not be as safe as they are perceived to be. One of such is the rate of inflation as well as the time value of money.

Also, while bond payments may be fixed and known by all the parties involved, the interest-rate environment is constantly changing.

The major benefit that investing in stocks has over bonds, is the ability to earn much higher returns. However, these returns are not over a predetermined or specified period of time like bonds.

In fact, with volatility in the short term really high, stocks might not outperform bonds until a longer period of time like years. So, investors who are willing to take on greater risks in exchange for the potential to benefit from growth in the prices of stocks/ equity, will opt for stocks.

Also, investors who are willing to wait the time required for the stocks of their choice to yield, will also opt for it.

However, investors who want to protect their principal and have a definite period of maturity for their invested securities will opt for bond investments. This is the tradeoff between stocks and bonds.

Written by Lawretta Egba.