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The Difference between Stocks and Bonds

As an investor, you have a plethora of options in front of you. Of course, you ought to explore all avenues to diversify better. Stocks and bonds, however, are the main classes of assets you can choose from.

When you buy stocks, you are buying a portion of a company. Meanwhile, bonds are like loans made to a company or other organization. Stocks are generally riskier than bonds. However, you must understand that these two assets have varying forms, with varying levels of risks.

Let us give you a breakdown or a comparison of these asset classes. Read on!

An infographic about the difference between stocks and bonds.
An infographic about the difference between stocks and bonds.

What are Stocks?

Stocks are basically units of equity, or ownership stake, in a company. The company’s value is the sum of all the outstanding stock of the company.

In other words, the price of the stock is practically the value of the company—its market capitalization or market cap—divided by the number of shares outstanding.

The company offers its stocks to investors—that might be you—during an initial public offering, or IPO. Stocks can also be offered in other later equity sales.

They offer stocks in platforms or exchanges like the NASDAQ and the New York Stock Exchange. This offers great liquidity, which means that you can turn investments into cash ASAP. What are Bonds?

As mentioned above, bonds are loans made to an organization. And since they are sort of debts, they’re considered as liabilities in the organization’s spread sheet.

Any organization can issue bonds, unlike stocks, which are typically offered only in for-profit firms. Here’s a piece of trivia: the governments of the US and Japan are two of the hugest bond issuers.

Just like stocks, you can also trade bonds on exchanges, although they have a lower volume than stocks.

See also: Things to remember when picking stocks.

Types of Stocks and Bonds

Types of Stocks and Bonds

Just like what we mentioned above, there are various kinds of stocks and bonds you can choose from. Some of them make for a better investment than others.

Types of Stocks

Basically, stocks fall under two main types: common stocks and preferred stocks.

A huge number of investors only buy and sell common stocks, while preferred stocks are divided into non-participating and participating stocks.

When you want to make a well diversified portfolio, you can try and check how you look at stocks:

Stocks by size – you can invest in small, medium, and large companies. But when you use stocks-speak, we refer to them as small-cap, medium-cap, and large-cap companies. For small-cap companies, market capitalization ranges from $300 million to $2 billion. Mid-cap, it’s between $2 and $10 billion. Large-cap companies, on the other hand, reaches above $10 billion.

Large-cap companies are fittingly more stable than small- and medium-cap companies. Investors normally think that small- and medium-cap companies are riskier. However, these ‘riskier’ companies offer a better return due to their growth potential.

Stocks by sector – you can also view stocks by sector. For instance, if you got your eye for information technology, you might want to invest a portion of your portfolio in there.

Standard and Poor’s 500 (S&P500) looks at stocks by dividing them into 10 major sectors. If you plan to invest by sector, remember to invest in a variety of sectors to lower risk.

Stocks by Growth – Some stocks grow quickly and can give you good returns, but they can be risky, too. Value stocks are more stable in the market and can likely give some return overall. However, they don’t usually have spikes or dips in value.

Stocks by Regions – you can invest in either or both local and overseas markets. When you invest in an international fund, you can put your bucks into stable markets. You can as well pour money into riskier emerging markets. Or you can do a combination of both.

Index Funds – if you think those first mentioned factors are overwhelming, you can use index funds as alternative. The NASDAQ-100 is an example of a stock index. Basically, it lists the top 100 large-cap stocks in the NASDAQ.

If you choose to put your money in a NASDAQ-100 index fund, your money will go equally to all the stocks within the fund.

On the whole, ideally, the entire index will grow and give you a return, even if some funds may decrease in value. Against other methods, index funds are a lower-risk investment especially for new investors.

Types of Bonds

Investors also call the bond market as the debt or credit market. It allows you to issue debts in the primary market, and buy and sell debt securities in the secondary market.

Government Bonds – if you are a government bond holder, you loan money to the government. The principal of a bond is paid back in full over time (with interest) as long as the government does not default. In the US, there are several types of government bonds, also known as “treasury securities.”

There are three main types of such securities: treasury bills, treasury notes, and treasury bonds. They mature and pay interests at different rates and in different ways respectively. Additionally, they require a minimum investment of $100.

Other types of government bonds are cheaper but they result in a lower return. Floating-rate notes offer a variable rate of interest based in the market.

Lastly, you can invest in the bond markets of other countries. Investing in established countries give fewer risks but doesn’t guarantee a good return. On the other hand, investing in developing countries is risky, but you could hit the jackpot.

Municipal Bonds – this refers to smaller, local governments (towns, counties, cities, or states). You can loan money to them. You will most likely do so to aid public projects like facility upgrades of hospitals and schools.

Corporate Bonds – this is where you can loan money to corporations. It is a riskier investment than government and municipal bonds, but potential returns are much higher.

If you want to avoid high-risk corporate bonds, you must use bond ratings, which rate the creditworthiness of a corporation. Organizations like Standard and Poor’s and Fitch Ratings provide such ratings.

Zero-coupon bonds – entities sell these types of bonds at a discount, usually with fixed interest rate. The rate only pays out upon bond maturity. Simply put, there are no periodic interest payments. Instead, the interest builds up or accrues (hence its other name, “accrual bonds”) over time. They are good investments, but there are drawbacks when it comes to their taxation.

Final Word

Your portfolio speaks tons about you and your investment attitude. When it comes to diversifying, knowing which asset is which, or which is better than the other, is always good. You must remember that you should invest in what you know. Stocks and bonds are just two of the assets you can choose from.

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