Stocks and bonds are the most affordable and popular financial instruments on the market, used for profit. It can be difficult for a novice investor to understand which of these securities to give preference to. Therefore, in our article, we will talk about the main advantages of these tools and compare them on key parameters.
Before you start comparing, you need to understand the main differences between property instruments (stocks) and debt instruments (bonds).
Stocks are issued by companies, and the investor, buying these securities, becomes a co-owner of the share capital and can receive dividends, which are accrued from the company’s income. Consequently, stocks are equity financial instruments.
Bonds can be issued by companies (corporate bonds), a state or region of the country and even a separate city (state and municipal bonds), which for their further economic development borrow money from investors. Therefore, these securities are debt, and the investor who bought them – the creditor.
Liquidity is the mobility of assets of enterprises, firms or banks, providing the actual ability to pay within the time of all their obligations and the legal monetary requirements. The most liquid will be those exchange assets that can be quickly and easily sold at the price closest to the market.
It is believed that stocks and bonds have the same high liquidity on the time-consuming criterion for their purchase and sale. To conduct any transaction, it is enough for the client to send the broker the appropriate order or to make an operation with securities on his own.
The speed of the operation to buy and sell these tools is mainly influenced by two factors – the volume of transactions and the size of the spread.
- The liquidity of security is directly proportional to the number of transactions made with a given paper on the stock market;
- And inversely proportional to the spread – the difference between the price of buying and selling a financial instrument at a certain point in time.
The profitability of property instruments depends on what type they belong to:
- Ordinary shares give the right to receive dividends to the co-owner only if the issuer generates net profit and by the decision of shareholders distributes it to dividend payments. At the same time, owners of ordinary shares can take part in the management of the company.
- Preferred shares may bring a fixed profit to owners, but do not allow them to vote at shareholder meetings and participate in management. At the same time, the profitability of these shares is usually higher at a relatively low cost compared to ordinary shares due to low liquidity.
Traders, as a rule, prefer ordinary shares, as they extract the main income by trading securities, and their liquidity is higher than that of the privileged.
It is important to emphasize that one of the main differences between bonds and stocks is that by purchasing debt securities, the client can immediately estimate their potential profitability.
Bonds are also divided into two groups on the form of payments, and their profitability depends on it:
- Discount bonds. At the time of purchase, the price of such bonds is less than face value, but at the time of repayment, the investor will receive their full face value. It is this difference and will make up the income.
- Interest (or coupon) bonds. Such bonds are purchased and repaid at face value, but the investor, depending on the maturity period, is given a profit of one-time or several payments (coupons).
On the sale of bonds can also earn, because at any time between the purchase and redemption the price will vary.
Comparing stocks and bonds in general, we can say that, as a rule, the profitability of shares in percentage terms is higher, mainly due to the unsized growth of quotations. Against the background of market changes or due to positive indicators, companies can significantly increase in price and bring a significant interest income on invested capital. However, this may not happen. Unlike investments in bonds, income, in this case, is not guaranteed.
The terms of investments
Stocks from bonds differ in that the first term of circulation is not limited, but bonds are issued for a certain period of time and divided by maturity for short-term (up to one year), medium-term (from one to five years) and long-term (over five years).
The term of investment is usually considered a time period, which is necessary to achieve specific financial goals. To get a small amount of time to profit, you need to make short-term investments, and for this, you can buy:
- Stocks for speculative transactions;
- Bonds, just before receiving interest income.
- Medium-term investments will be needed to generate a stable profit over a long period of time:
If we consider the main risk of liquidation of the company that issued securities on the market, then the security of these financial instruments can be distributed as follows:
- Preferred shares;
- Ordinary shares, that will receive a share payment.
There are other concepts associated with risk:
- Dangers arising from different trading styles. The most likely to suffer losses can be a trader with an aggressive approach to investing, making a huge number of transactions with shares every day. It doesn’t work with bonds.
- The maximum allowable level of risk that each investor sets for himself with each trading decision.
Any financial instruments can become unreliable in developing countries, as there is a high probability of any crisis escalating into default and hyperinflation, as well as high legal risks.
The bottom line
Here are some conclusions:
- Stocks and bonds in comparison on liquidity and terms of investment are equal.
- In profitability, stocks outperform bonds.
- The reliability of bonds is higher than that of preferred and common shares.
When choosing any tool and strategy to work with it, only two parameters will be plus for the investor, the third – always a minus. At the same time, the term of investment can affect all three characteristics both positively and negatively.
Summing up the results, we note that despite the attractive yield of shares and high reliability of bonds, the best option is the presence in the investment portfolio of different securities, comparable to each other in both quantity and value.