Investors consider bonds as a lower-risk investment as the prices for bonds are more stable than the stock prices. Stocks are considered a higher-risk investment as they are volatile, and depend on market fluctuations.
Explanation:
Stocks represent a stake in a given company. If stockholders own 51% of the company’s shares, this allows them to influence the financial decisions of the company and appoint people to the board of directors. However, they do not have rights for the company’s assets and property. A company may pay dividends on profits to shareholders. Dividends arise and are paid at the discretion of the board of directors.
Stocks are considered a higher-risk investment as they are volatile, and depend on market fluctuations. At the same time, the growth in the value of shares on the market can average 10% per year.
If your stocks have plummeted, it may take 5 to 7 years for them to regain their liquidity level. That is why stocks are considered a longer-term investment than bonds.
The level of stock volatility may depend on the following factors:
- The country where the company does its business (geopolitical risk);
- Fluctuations in the foreign exchange markets (currency risk);
- Profitability and success of a company’s business (liquidity risk).
Bonds are a form of long-term debt. The issuing company agrees to pay the bondholder a fixed interest rate until the maturity date (usually twice a year), plus the principal amount at the specified maturity date. Governments use bonds to finance government expenses, and companies – to finance company costs. These are the means for business development, implementation of profitable projects, refinancing company loans.
Bonds are a short-term investment since the issuer starts to make payouts within the first year. The amount of interest rate payouts is generally quite low, about 4% per year, given that the inflation rate is 3%.
Investors consider bonds as a lower-risk investment as the prices for bonds are more stable than the stock prices. Bondholders can sell bonds on the market, just like stockholders. The bond price is calculated with the subtraction of the amount of interest already paid to the bondholder.
Bondholders also need to consider various risks:
- An increase in interest rates (payouts) always indicates that bond prices are falling (interest rate risk).
- The nominal cost of bonds is a subject to inflation risk.
- The credit risk emerges when a financially unstable issuer does not pay interest or defaults.
Experienced investors advise distributing the investment portfolio between stocks and bonds. While the young entrepreneurs are more prone to long-term investments, such as stocks, investors who are preparing for retirement consider bond investments to be more profitable.
