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Last Updated: Feb 18th, 2008 - 14:39:01 |
Stocks Better than Bonds?
Bonds are debt securities issued by institutional entities intending to borrow for productive purposes. Issuing authorities can be government entities, corporations or finance companies and the likes. Such issues mean that the issuing entity agrees to owe the holder a debt payable on the promised repayment date. It is a paper of contract between the borrower and the lender of the IOU type, accompanied by a promise to repay with additional earning and interest payment.
One main similarity between bonds and stocks lies in the fact that both are traded in stock exchanges. As it is with stocks, bonds also have a face value that fluctuates according to the confidence level of the investor in the issuers ability to repay the bond on promised dateline.
However, contrary to stocks, which are equity securities, bonds as debt securities that have certain specific qualities.
Trading in bonds seems to be quite popular among investors as they are generally taken as a more reliable investment than stocks. There is an sum-assured component in bonds which is absent in stocks. In case of bonds you have a fair idea about when and hw much you'll be repaid, and while you're waiting you will earn an interest for having invested in the bond issue.
Bonds usually accrue interest like a savings account, which is payable either quarterly, half yearly, or annually. This may make one conclude that bonds are better investments than stocks. A stock investment market will never promise any interest or for that matter any promise of positive earning at all.
Bonds look better on another count also. They are often convertible in to equity shares.
Like in stocks, there are many varieties of bonds. Bond varieties refer to the rates of interest, distance of repayment terminal time and nature of conversion ratios, while stocks vary according to the size and probable income potential, which have to be calculated by the investor himself.
But this 'higher worthiness' is not always very well founded. There are bonds that do not pay any interest but guarantee the full repayment of the principal zero coupons for example. But in a sense that is true with stocks also. The only difference is that you have to be alert to avoid missing the purchase value by agreeing to sell them at the right time. Earning from bonds may vary according to the nature of the bond, whether it is a fixed rate or a floating rate bond.
The main demerit of bonds vis-ΰ-vis stocks is that a bond can never earn more than its face value, while a prosperous stock can earn large multiples of its face value.
This statement needs to be qualified for convertible bonds, which can conditionally (dependent on the occurrence of certain events) be converted into equity stocks of the issuer, rather than being repaid in money. From that point onward it is identical with any other stock in quality.
Bonds can be advocated to be better than stocks for people who are allergic to risks and are happy with lower earnings. For people ready for financial adventure, stocks are the way to go.
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