A bond and a share of stock are very different in their structure as investments, their safety, their use, their availability and their price. When you buy bonds, you are presumably seeking safety of principal and semi-annual income on your investment. Stocks provide the potential for price appreciation and, if they pay dividends, quarterly income.
Debt vs. Ownership
When you buy a bond you are loaning money to the company that issued the bond, so bonds are evidence that you are a creditor of the company. Bonds are called debt or credit instruments and are sold in units of $1,000 in par value, with market prices trading at a percentage of that amount. When you buy stock you are purchasing a fractional percentage of the company and, as a shareholder, you are an owner of the company. Stock is evidence of ownership and is often referred to as equity and the price of a share of stock is generally under $100.
Safety vs. Risk
Like most loans, bonds are expected to repay principal at maturity and, in the meantime, pay interest every six months. The amount of interest depends on the credit quality of the underlying company. The better the credit, the more likely you will receive your principal back at maturity along with timely interest payments and the lower the interest rate. This is why bonds are considered safer investments than stock. As a stockholder owner of the company, you participate in its success or failure, so your stock will fluctuate in price according to the performance of the company. If the company goes out of business, you will have a subordinated call on the assets of the company, behind the bondholders. This is why stock is considered a riskier investment than bonds.
Use as Investments
Bonds are also called fixed-income investments because they pay a set amount of interest semi-annually. For this reason they are popular retirement investments, and because of the safety factor, are used in bank treasury portfolios and insurance company portfolios. Stock that pays dividends also is used in retirement and insurance portfolios, but non-dividend-paying stock is primarily purchased for its price-appreciation potential.
If you are trying to decide whether to invest in bonds or stock, consider your investment needs and goals. Standard asset-allocation theory suggests that if you are in your twenties or thirties you should have from 50 percent to as much as 75 percent of your portfolio invested in stock for the price-appreciation potential. As you age, you should diminish your stock investments and buy bonds until you have 80 percent bonds as you approach retirement.
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