The question of investing in equities or bonds is one that has baffled the American public for years. The vast majority of people often think of these terms in interchangeable ways. They see professional financial management as investing stocks and bonds and do not differentiate between the two.
But skills that are useful in trading stocks are not always particularly helpful in trading bonds. Stocks and bonds really are two different aspects of the economy and different theories about how to make money. Knowing the difference is essential to determining what allocation should be given in any portfolio to either one of these classes of financial assets.
What Are Bonds?
Bonds are financial assets that have a fixed rate of return and are paid out fully at the end of that term. They are a means for a government or corporation to take on debt that is defined and accepted by all parties. These financial instruments have a number of different attributes.
There is the face value which is the amount that the bond was purchased for. The coupon rate is the amount of interest that the bond will pay out. This coupon used to physically be included on the piece of paper that constituted the bond.
The bond also includes a stated maturity date. This is the date when the bond has fully paid out both principal and interest to the investor. Bonds are used to raise money for a wide variety of projects within companies and government entities. They are a steady, predictable form of debt that are best for school initiatives and capital improvement projects established by the issuing entity.
What Are Equities?
Equities are small pieces of ownership in a company. They often take the form of shares of stock. A company offers equities in order to raise money for a wide variety of projects within the company.
These equities are privately held or publicly traded on an equities market. Equities are issued in a number of different ways. There are common shares that are sold on stock exchanges and often fuel the content seen on financial television and finance websites.
There are also preferred shares. Preferred shares are more expensive than common shares and mostly make money through coupons similar to bonds. The shares contain less risk than common shares but less upside as well. The biggest benefit to preferred shares is that they are often paid out before common shares if a company ever goes bankrupt.
Benefits of Bonds
Bonds are often one of the safest forms of investment on the market. They pay out defined amounts of money over a period of time. The risk of bonds is even lower when one considers bonds from the federal government.
These bonds are backed by the full faith and credit of the United States. They will only lose their value if the federal government collapses. They are just as safe and secure as savings in a savings account or a checking account.
Both FDIC insurance and money for bonds draw from the same taxpayer funds in order to prop up their value. A person can determine the exact amount of money that they will derive from their bond over years or even decades.
Downsides of Bonds
The largest downside to bonds is their low interest rate. All but the riskiest form of bonds offer only a few total percentage points of interest. This low interest rate means that the bond often cannot keep up with inflation.
It can lead to a person losing real value of their money over an extended period of time. The bonds that do pay large interest rates are often spread out over a period of decades. Locking a person's money into a bond for thirty years removes a considerable amount of flexibility from their investing decisions.
There is also the strong possibility that a company offering a bond may go bankrupt. The ratings system of bonds revolves around the idea that a company or municipality will or will not be able to pay the bond back. Few municipalities have gone out of business and been able to pay back bonds, but a large number of companies certainly have.
Benefits of Equities
The greatest benefit to equity trading is the considerable upside that equity trading may provide. Equity trading has the power to completely secure an individual's return. The proper trading of equities is the way that a large number of people who are not born into wealth become millionaires.
Smart equity trades that minimize downside and maximize the research on companies and trends can help turn financial insecurity into a considerable retirement nest egg. Buying and investing in index funds or mutual funds can help a person achieve their retirement goals on their own. Equity investment will do things that bond investment simply is not equipped to do.
Bonds in most instances will not make a person wealthy over time. The lower risk of bonds means that their upside will always be kept low. The fluctuations and precipitous drops in the stock market offer an incentive for much higher gains.
There is always the chance that a person will hit an investment at the right time and that the investment will balloon in value. Individuals have become enormously wealthy trading stock in some of the largest companies in the country such as Apple, Google, and Tesla. These companies are so large that there is a decent chance the federal government would step in to protect their stock prices if they ever did go out of business.
There is also the ability to passively invest a large volume of companies. Index funds buy and hold shares from a large number of companies over an extended period of time. This approach to investing can lead to portfolio increases of between ten and fifteen percent a year.
There is also a minuscule chance that a person can lose the entirety of their investment. While individual companies or municipalities may go out of business, there is almost no chance that the entire stock market index will lose all of its value outside of an apocalypse.
Equities are also much more liquid than bonds. Liquidity refers to the ability of individuals to move their money around and turn it into cash at any time. Bonds have to be held for an extended period of time in order to accrue their benefits. Buying and selling bonds is not the usual approach that bondholders have and removes many of their safety benefits. Equities, on the other hand, can be bought and sold on a whim.
Downsides of Equities
The greatest downside to equities is their volatility. A bond can have its payments and interest rate set over a period of decades. The value of equities can sometimes fluctuate by the second.
There is the ability for a large number of individuals to make questionable or downright dangerous moves when they are investing in stocks another. There are laws in place to prevent many types of illicit actions with equities.
But there are also large numbers of companies that are poorly run and lie about their situations. An alarming number of companies that are traded on equity markets in the United States and around the world have aspects of their business that could cause problems for shareholders. If a company goes bankrupt for any reason, there is a considerable chance that all of their investors will lose practically all of their money in the company's stock.
A person who dabbles in equities and puts all of their money in single stocks is trusting their future to the morals and legal behavior of a handful of individuals. While it is possible to invest in a sane and reasonable way when investing in equities, it is also possible and arguably more attractive to invest in a way that puts a person's entire life savings at risk.
In addition, the field of equities is rife with unscrupulous salesman and schemes marketed as if they are sure bets. These advertisements have duped millions of people over the past century and there is always the chance that an equity investor will fall for one of them
What to Do
Anyone who is trying to decide between investing in equities or bonds should begin by learning what their goals are in investing. They should learn if they are trying to save for retirement or attempt to become wealthy in a short period of time.
They should determine how much money they are willing to invest and how much of that investment they are willing to lose. If they are older and are about to retire, they need to take on less risk in their portfolios which means that they should lean towards bonds. These individuals should not completely eschew equities, however.
Many index fund and mutual fund strategies can be helpful for older people or younger people who are not interested in taking on much risk. But they definitely need to start looking towards bonds in order to meet their investment goals with the limited amount of risk that they are interested in taking. People who want to take more risk and are fine with losing large amounts of money should consider riskier ventures such as emerging economy mutual funds and single stock strategies.
It is not recommended that anybody investor retirement savings in single stocks or in high-risk equities. Losing all of a person's money in these ventures can lead to a stressful retirement and years of heartache and worry later on.
But people sometimes look at equities like they look at lottery tickets are other means of spending money for enjoyment. In that case, an equity can be much more beneficial in the end.
Equities can help a person greatly maximize the amount of money that they have to spend and can give them a means to learn more about how the economy and markets work than bonds. Once a person decides how they want to invest and where they want to invest, they should start to talk to investment professionals who will give them the tools they need to buy and sell equities.
For decades, stock investment companies charged individuals to trade either stocks or bonds. This practice reduced the liquidity of these assets and push people to hold them for longer than they would have otherwise. This practice is changing, however.
More and more companies are opening every day that allow their users to trade stocks for free or for pennies on the dollar. In this instance, an individual may lean more towards equities than they would have otherwise because the costs are so much lower. The cost of investing need to be a factor when they are looking at investing in bonds versus equities.
The question of investing equities or bonds is one that millions of people grapple with on a regular basis. There is no perfect answer for every individual. It takes time, research, and introspection in order to decide which of the world's investment vehicles is right for any person at any one time.
An individual has to determine whether or not they are the type of person who can take on some sort of risk with their money. They must decide what they are willing to put up in order to potentially secure a higher return that will hasten their retirement. Only by asking these questions and making these decisions can a person make the perfect decision on how much money they should invest in bonds and equities in their portfolio.