Should Corporations Invest in Stocks or Buy Bonds?
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Stocks Provide Greater Return
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Over a long period of time, the stock market has historically provided a greater return on investment than the bond market. As a result, investing in stocks gives corporations significantly larger potential earnings. In addition, a diverse portfolio can eliminate nonsystematic risk and improve a corporation's chances of earning a positive return.
Bonds Are Less Risky
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Although bonds have historically generated a smaller return than stocks, they are also far less risky. Bonds with very little default risk, such as U.S. government bonds, are considered a risk-free investment. In addition, without a default a bond investor is guaranteed a certain return based on the set interest rate, while stock owners cannot definitively predict future earnings.
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Bottom Line
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While stocks provide a greater return, bonds provide a far less risky investment. A corporation must decide what its risk profile is and its required rate of return. Although investment philosophies vary based on risk aversion, most corporations should create a mixed portfolio with both stocks and bonds.
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