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Basic Understanding on Stocks and Bonds

Key Points

  1. There are differences between stocks and bonds.
  2. Getting stock is like owning ownership or equity interest in the company you invested in.
  3. Buying bonds is like lending money to the company, which you will get paid back with interest.

Investing your money is a significant decision. You have to be careful and considerate because if you don’t, the risk of losing some or all of what’s invested becomes higher. A well-diversified portfolio strategy is recommended before you start to buy assets such as stocks and bonds.

There are many different types of financial markets in which stocks and bonds can be bought, sold or trades made. However, stocks and bonds may seem like two sides of the same coin when it comes to investing, but there are stark differences between them.

What is stock?

Stocks are one of the most common ways for people to invest in businesses and earn a return on their money. When you buy stock, it’s like owning part ownership or equity interest in that company. The more you buy, the greater your share of that business’ profits and potential future success!

Stocks represent a company’s ownership in itself. They may be issued to the public for many reasons, but most commonly, this translates into raising money that can fuel future growth.

Imagine if the company you invested in is doing well, you are getting rich with their success as you own a slice of the company. However, when the opposite happens, whereby the company performs poorly, you could lose money if you sell them.

What is bond?

Buying a bond is like lending money to a company or government and getting interested in your loan. There’s no equity involved, and it is not entirely risk-free. You might not receive your entire principal if they go bankrupt before paying back everything.

To many, bonds are safer and more predictable investments than stocks. You know precisely what you’re signing up for with a fixed interest rate that will be paid regularly over long periods. Bond interest rates can vary depending upon the type and duration, commonly ranging from a few days to 30 years.

Differences between stocks and bonds

Stocks and bonds are the two most popular instruments for growing your money but in different ways. Stocks and bonds are two different ways to invest in the market; stocks give you partial ownership, while most bonds pay fixed interest over time.

Stocks generate profit through appreciation in value. But, they need to be sold on a stock exchange, or else there would be no way of getting your money back. Bonds provide incentives from lending out funds at fixed interest rates over time instead. Both investments are not entirely risk-free, but getting stocks has higher returns due to market volatility.

Equity vs debt

Many different types of investments can be considered liquid financial assets. One example is equity, which gives investors access to future growth and success for their money invested. It’s like owning a piece (or shares) of the company you invest in

When you buy a bond, the company asks for your financial assistance (debt) in exchange for an interest rate and repayment date. You won’t have any ownership stake, but you can get interest rate repayment and the principal amount at the end of that period.

Capital gains vs fixed income

As we mentioned above, stocks and bonds generate money differently.

If you’re looking for a way to make money from stocks, selling shares at higher prices than what was paid will generate profits. Capital gains can be used as income or reinvested, but they will be taxed accordingly.

If you put money into a bond, it will generate cash through regular interest payments. The frequency can vary but is generally as follows:

  • Treasury bonds and notes
  • Treasury bills
  • Corporate bonds

Bonds are one of the most preferable investments for conservative investors. As long as the company did not go bankrupt during the repayment period, you will enjoy annual returns with interest until your principal has been fully repaid.

Inverse performance

Stocks and bonds are two different financial products that can confuse investors. Stocks have an inverse relationship with bonds; for example, when stock prices go up, bond prices tend to fall and vice versa.

When the market is up, people buy stocks and pour money into them, which means there will be lower demand for bonds. Conversely, investors tend to target lower-risk and lower-return investments such as bonds if the stock market is dropping. Therefore, their demand increases, with their prices too. Bond performance is also closely tied to interest rates.

What are the risks for both investments?

  • Stock risk
  • Stock investments are typically riskier than bonds. Several reasons caused fluctuations in the stock market. In short, when the company you invested in underperforms, its stock price could fall. Therefore, selling stocks with a lower value than what you paid might result in losing money.

  • Bond risk
  • Corporate bonds are not entirely risk-free even though the risk is lower than stock. If a company is more likely to go bankrupt, its bonds are considered much riskier than those of another organization with low chances. A credit rating reflects how likely a company will pay back the debt to their investor.

    Corporate bonds can be categorized into two types:

    1. Investment grade – High credit rate, low risk, low return
    2. High-yield – Low credit rate, high risk, high return

Which one should I choose to invest in?

It really depends on personal risk tolerance. If the goal is to have stable long-term returns, you might consider investing in bonds, but if you are willing to enjoy some high-risk, high-return investment, stocks are more suitable.

The volatility of the stock market is something that many people fear as they age. Bonds are less volatile than stocks; hence if you allocate more money toward bonds, you’ll get peace of mind. This is because there will be a fixed repayment every month until the principal fully pays off.

Verdict

Investment in either bonds or shares is an investment that requires a great deal of commitment. It’s essential to first assess your tolerance for risk before investing any money. Do not invest all your money into one company (stocks and bonds), especially if doing so means risking all of the funds and financial stability. Instead, gain advice from a professional financial advisor for guidance.

Consider investing in unit trusts if you want to diversify your portfolio with lower budgets. Click here to learn more.

Related: Top 5 High-Risk Investments in Malaysia | Top 5 Low-Risk Investments in Malaysia

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