Stocks and bonds are popular investment products offered by corporations and government entities. Both stocks and bonds carry unique advantages and disadvantages to the issuers and the investors. Familiarizing yourself with the difference between bonds and stocks can help you to decide which investment, or mix of the two, is best for your household.
Corporations issue stocks and bonds for a single purpose: to raise money from investors. Companies may seek investor funding for a variety of reasons, including to fuel expansion plans, to fund acquisitions and to meet the organization's obligations during temporary financial setbacks. Investors also invest in stocks and bonds for a single purpose: to boost their individual income. Stocks and bonds both have long-term, fixed income options and short-term, trading income options.
When corporations or governments need quick money, they can choose to issue bonds to investors for a quick inflow of capital. The bond-issuer pays bond-holders a specified amount of interest each year, then repays the face value of the bond — the amount the investor originally gave the issuer — at the end of a specific period. As with stocks, investors can choose to hold bonds until maturity, collecting annual interest payments and recouping their original investment upon maturity, or they can trade bonds on the bond market for quick capital gains.
Stocks have many more strings attached than bonds. Stocks are essentially shares of ownership in a company, granting shareholders the right to vote on vital company issues. Unlike bondholders, stockholders are a part of the company until they choose to sell their shares either to another investor, another company or back to the issuing company itself. Stockholders can hold their shares indefinitely to collect dividend revenue, or they can sell their shares when the market price rises enough to make them a profit.
Both stocks and bonds offer win-win solutions to issuers and investors. Issuers receive the money they need to continue or expand their operations, allowing them to reap larger profits in the future. Investors gain the benefit of increasing the value of their wealth through capital gains or interest/dividend income.
Both stocks and bonds represent liabilities that are more complex than traditional bank loans. Companies must think long and hard before choosing to issue these unique securities; taking a company private after issuing shares of stock can be particularly challenging. Investors bear risk when purchasing stocks and bonds. Stocks carry the risk of devaluation or altered dividend-payment policies. Bonds are generally less risky, but there is still the risk of default if the issuing company closes its doors.
- stock exchange image by Christopher Walker from Fotolia.com