By Alex Dixon, YouCanTrade
While stocks and bonds are often mentioned in the same breath, they are quite different. A stock is a specified portion of a company issued in shares (a certain percentage of ownership of a company) while a bond is an instrument of debt designed to help raise funds. Stocks and bonds have pros and cons for investors and traders and companies.
Stocks are a great tool for companies since they have no obligation to repay investors the funds they have received for the purchase of the stock. Bonds are great when a company wants to keep its ownership, but still needs to raise funds. On the other hand, selling stocks causes the ownership of the company to get diluted. And, with bonds, companies are obligated to pay back the investors with the specified interest.
Bonds are special because they can also be issued by governments, but governments (at least in the United States) cannot issue stock. Let’s say California wants to build a high-speed train from Los Angeles to San Francisco. The state government could issue bonds to raise funds for this specific project and repay the investors as the train is projected to earn revenue from ticket sales.
How does this effect traders and investors?
Stock price could rise infinitely in value much faster than any pre-determined specified amount. On the flip side, stock can stay stagnant or even drop to zero. Bonds, however, are based on a contracted amount to be paid to the investor. Meaning, even with bonds, investors could miss out on rapid gains and, if those bonds are not backed properly, could also go to zero if the issuer defaults on its payment obligations.
When weighing whether to purchase stocks or bonds, make sure you understand what you are committing to. Consider your needs and how those stack up against the pros and cons of stocks and bonds.