Stocks and bonds as investments
In the following section, we will discuss in more depth the pros and cons of owning stocks, from the point of an investor rather than the borrower. This will allow us to understand why private investors and companies would invest in bonds and stocks.
Firstly, let us discuss some of the pros and cons of owning stocks. [1]
| Pros | Cons |
|---|---|
| – Stocks give you ownership. When stocks are purchased, the investor will have equity in the company.
– Stocks potentially have large gains. They provide above-average returns when compared to bonds. – Keep up with inflation. With interest rates at all-time lows, savings accounts do not offer the same rates that they used too, and as such they do not keep up with inflation and can lose value over time. Of course, there is no guarantee that a stock will outperform inflation; however, in a broader investment portfolio sense, they should provide stable growth. – Stocks have the potential to offer dividends. Not all stocks will pay dividends, however those that do provide a nice income stream. – Stocks are liquid. Most stocks are highly liquid, which means they are easy to buy and sell and thus provide ample opportunity to reduce risk. |
– High exposure to risk. When a company or private investors invest in stocks, they have to be aware of the risk that comes with that, and it may not be suitable for all investors to chase higher returns simply.
– Common stocks have no entitlements. When companies go bankrupt, common stockholders are the last to be paid. – Dependant on market demand. The investment community plays a large part in determining the value of stocks and, as such, there is significant exposure to a ‘what the market thinks’ mindset. |
Let’s now look at bonds, which are considered more safe than stocks, however obviously do not have as high of a return. [1]
| Pros | Cons |
|---|---|
| – Protection from loss. They are safer than stocks, they are less volatile as bonds are debts and won’t rise or fall with investor opinion, they have clear-cut terms and requirements.
– Consistent returns. As we’ve discussed, bonds have known rates, expiration dates, and clearly set out terms, thus investors who purchase them will know their returns over the lifespan of the bond. – Increased guarantee of payment. When companies face bankruptcy, bondholders sit higher in the pecking order compared to common stockholders. – Passive income stream. The coupon rate that bonds pay is a manner in which investors can outperform inflation whilst preserving capital. |
– Smaller returns. Lower risk means lower return, and perhaps they are not suitable for all investors.
– Liquidity concern. Bonds are not as easy to sell compared to stocks. As such, if an investor needs the capital, it might be harder to obtain. – Large initial investment. Bonds have larger initial investments as they are usually sold in higher denominations, whereas stocks can range from pennies to thousands. |
To determine which is more suitable for a company with excess funds to invest in, or a private investor, will vary greatly. It is important to understand the fundamental differences and what each provides in order to determine which is more suitable, and, as such, there is no right or wrong answer when considering which to invest in.
References
1. Rodriguez, J. Investing in stocks vs bonds – differences to consider [Internet]. Money Crashers; 2020 Jul 29. Available from: https://www.moneycrashers.com/investing-stocks-vs-bonds-differences/
Financial Analysis for Business Decisions: Cash Flow Management
Financial Analysis for Business Decisions: Cash Flow Management
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