Sameer is a 21 year old executive. He has just begun his job at a company. His pay is meager but he is contented and wants to start investing.
One day, he was talking with his brother, Ranveer casually and the topic of investment came up. Sameer confided in him that he wanted to invest. Ranveer understood that his younger brother, who was a young boy playing basketball with him till now, had grown up and was talking about investing. As the conversation proceeded, Ranveer suggested Sameer to try investing in stocks and bonds.
Sameer asked Ranveer what a stock is and what a bond is. Ranveer smiled at this young man who was still his cute brother and said “Come to the garden. As we enjoy the breeze, I will tell you what a stock is, what a bond is, and many other things you ought to know!”
What is a Stock?
A stake of ownership in a company which is sold off in exchange for cash is known as a stock. This stock is a security in the company and is also referred to as equity or a share. It signifies ownership in firm and represents a claim on part of the corporation’s assets and earnings.
A holder of stock is known as a shareholder. He/she claims a portion of the company’s income and assets. The shareholder is the owner of the corporation and ownership is driven by the number of the number of shares you own relative to the number of outstanding shares.
What is a Bond?
A bond is a debt that the entity enters into with the investor which will pay the investor interest on that debt. It is an instrument of indebtedness of the bond issuer to the holders. You loan money to the company that will borrow funds for a specific epoch at either a variable or fixed interest rate. Owners of bonds are debt holders, or creditors, of the issuer.
Also referred to as “Fixed Income Securities”, Bonds are issued directly to investors rather than borrowing money from banks. The issuer, also known as the indebted entity issues a bond stating the interest rate to be paid and time at which the loaned (mutual funds) (bond principal) must be returned (maturity date). The coupon rate (or interest or payment) is the return bondholders receive for loaning their funds to the issuer.
Pros of Stocks:
- In the long term, stocks earn better than bonds
- Stocks can offer better returns if the company growth is exponential
- Great for investors with high risk appetite due to the rise in company stocks
- Some stocks pay dividends, which can cushion a drop in share price, provide extra income or be used to buy more shares.
Cons of Stocks:
- Stocks make no promises of future returns on initial investments
- Easy to lose money by investing in the wrong stocks due to unpredictability
- Prices can rise and fall apart from no guaranteed returns
Pros of Bonds:
- Lower risk than stocks due to fixed interest rates on loans
- Resilient to changes in interest rate fluctuations in the economy (Great to own during uncertain times)
- Rise and fall less compared to stocks so less price fluctuations
Cons of Bonds:
- Bonds don’t have as much income potential as stocks
- Lower long-term returns than stocks.
- Bonds, especially long term bonds, suffer from price fluctuations
“These are the important things you have to fundamentally know about stocks and bonds, Sameer” said Ranveer.