Let’s get one thing clear immediately: stocks and bonds are not the same investments. But you probably already knew that since one is called “stocks” and one is called “bonds.” What you may not understand — yet — is the difference between the two.
But I promise that soon you will be able to hold your own at a cocktail party when the conversation turns to: “Bonds are increasing in value; I think stocks are going to plummet” among the investing savvy.
It’s really very simple, and here’s the very basic difference between the two: owning a stock means that you own an actual piece of the company behind that stock. That’s why a stockowner of General Electric gets invited to the shareholder meetings: she is actually an owner — albeit a teeny one — of General Electric! Pretty exciting to think about, isn’t it? Every share of G.E. that you own means that you care about the future of that company; you want to know how it is going to perform in the coming months, years and decades. Is it going to make you money … because you are, after all, one of the owners.
Bonds, on the other hand, mean that you have only loaned money to that company; you do not own a piece of the company. You have bought some G.E. bonds, issued to raise money for the company (raising money is the usual reason for issuing bonds). They usually pay a fixed amount of return for a fixed amount of time. (It is a bit more complicated than that, but enough for now to think about and absorb.) It is as if an officer of G.E. came to you and asked you to loan the company some money. “We’ll pay you back,” he promises, and upon that good-faith statement, you can count on x amount of income over the life of the bond.
Stocks are issued by the company which you buy: General Electric, Starbucks, Google, all publicly traded companies have shares of stock in their company to sell to the public.
Bonds can be issued by corporations, countries (i.e., U.S. treasury bonds, savings bonds), counties and cities. They are called fixed-income assets because you know what profit you’re going to make when you invest. A certificate of deposit at a bank, for example, is a kind of bond. You are basically loaning the originator of the bond the amount of money of the face value of the CD for a certain period of time in exchange for a specified rate of return, called dividend yield or interest.
Bonds are for people who don’t like surprises. When you buy a bond, you know up front what the profit is going to be, and it will be that amount – barring something really bizarre happening. (No investment is 100% safe and secure: banks fold, governments collapse, companies declare bankruptcies, even mattresses can be pilfered by thieves or destroyed by fire.) If you buy a 6% interest-yielding bond for one year, for example, at the end of that year you will have $1,060, not a penny more or a dollar less.
Pretty exciting, huh?
Not really. Just safe and secure, which makes some investors very happy. Stocks, on the other hand, can fluctuate wildly, based on how the company does, how the economy does, how the stock market does. You could make 6% or 20% or lose 4% on any given stock in the course of a year.
Statistically, the investment world favors the stock market: stocks have outperformed bonds overall for decades. However, as you age, it’s a good idea to have some fixed income investments that are safe and sound so that you can sleep well at night. The older you get, the less chance you will have to make up the loss from a bad stock pick.
So think of stocks as company ownership and bonds as company lending and you will have the basic difference between these two investment vehicles.
Since most of us are stock investors, we’ll learn in much more detail what stocks are all about in the articles to come. There’s a lot to learn, but it’s great fun, very interesting and challenging, and can make you a bundle of dough if you do the task right.