What Is the Main Difference Between a Bond & a Share of Stock?
There are many types of investment vehicles where people place their money in the hopes that it grows over time, so that they can build personal wealth. Two of those vehicles are stocks and bonds. Some people tend to get confused with stocks and bonds because they both have to do with investing alongside a company. There are a few main differences between stocks and bonds.
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Ownership
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One of the main differences between stocks and bonds is that when an investor invest in stocks, he owns a piece of the company. When an investor invests in bonds, he does not own a piece of that company. As an example, pretend that company X has one million shares on the market. If you as an investor bought 2,000 of those shares, you would own .002 percent of that company.
Your investment then rises and falls with the success of the company because of your ownership. However, if you decided to buy bonds from company X, you would not own a piece of that company, because when you pay for the bond, you are essentially loaning the company money. Companies issue bonds to raise capital. So if the head of company X decided he needed money, but did not want to sell any more pieces of his company, he might issue bonds, where investors would receive an interest rate on their money for investing in the company.
Volatility
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At it's simplest form stocks are exposed to volatility and bonds are not. This because when an investor buys a stock he is hoping for it to be worth more tomorrow then it is today. If he's right, he makes money; if he's wrong, he loses money. Bonds are not exposed to volatility, because when the investor buys a bond he knows exactly what he will get back at the end of the term because the interest rate is guaranteed.
So using company X again, if an investor bought $10,000 worth of stock in company X, it might be worth $20,000 at the end of the year or it could be worth nothing at the end of the year. While those are extreme examples, it seeks to illustrate that there is now finite gain and only a finite loss to 0 governing the investment of a stock. However, when you invested $10,000 in company X for one year and were guaranteed a three percent return, you would receive $10,300 by years end.
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Priority
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Because a bond holder is someone who essentially lent money to a company, and a stockholder is someone who owns a piece of that company, a bond holder takes priority when it comes to payment. This becomes quite important during a bankruptcy procedure, because as a company is reorganizing during the bankruptcy process, the bond holders are paid out before the stockholders when the assets are divided.
Time Frame
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When you buy a share of stock, there is no fixed date when you will close your position in that security. You can sell the stock in the next few minutes or hold onto it for years to come. However, when you are a bond holder, and essentially a lender to the company, there is a fixed date when your investment will be over. You can certainly choose to re-invest if the company again issues bonds, but once the maturity date hits, you will be paid what has been promised on the bond note.
Return on Investment
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The bottom line for many investors is the return on investment (ROI) that investing in a stock or bond might bring. In the 2009 edition of the Morningstar book "Stocks, Bonds Bills and Inflation," there was a snap shot as to the ROI an investor would have gotten had he invested $1 in large stocks in 1925 versus if he had invested $1 in large corporate bonds. That $1 would have grown to almost $175 by 2009 in large stocks, but only yielded just under $10 in corporate bonds over the same time frame. Many financial advisers recommend creating a portfolio that is balanced with both stocks and bonds to gain a stable return over time. This is meant to limit the volatility of the stock market, and utilize the security of the bond market.
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