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What is the difference between a stock and a bond?

Jan 04, 2012 by Dan from Ventura, CA in  |  Flag
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Purchasing the stock of a company provides investors with an ownership interest in a public company. It gives the investor an opportunity to participate in the appreciation and depreciation in the price of the stock over time. Additionally, stockholders may receive dividends, which are distributions of corporate profits made at the discretion of a company’s management. Equity securities tend to be highly liquid and can often be bought or sold electronically within seconds. This also means that equity prices can fluctuate significantly within a short period of time. News reports, public company filings, and even rumors can cause the price of a single stock to rise or fall in value. As such, investors are strongly urged to diversify their investments when holding individual equities to minimize risk within their portfolios.

Bonds allow investors to collect interest paid on corporate and governmental debt. Interest may be paid periodically in cash, or through a single appreciated amount in the future (zero-coupon bonds). Unlike dividends, entities that issue bonds are required to make the payments to the debt-holders as described in the issuing documents. Bonds may produce a more steady income stream than holding stocks. However, they are subject to credit risk, as the ability of the issuing entity to make its payments in a timely manner is tied directly to its financial stability. Therefore, riskier entities will generally issue debt which pays a higher percentage return than more financially stable entities. In addition, bonds are subject to interest rate risk in that bond prices tend to fluctuate in relation to changes in market interest rates. As such, investors are strongly urged to diversify their investments when holding individual bonds to minimize risk within their portfolios.

1 Comment   |  Flag   |  Jan 04, 2012 from Staten Island, NY

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Carolyn Taylor Level 15

There are several differences between stocks and bonds, and more specifically common stock and corporate bonds; which are commonly just called ‘stocks and bonds’ by the general public. There are a plethora of other instruments such as preferred stock, municipal bonds, zero-coupon bonds and convertible bonds which are differentiated by their taxation, yields, capital payout structure and several other variables. For the purpose of this question, let’s focus on common stock and corporate bonds, both issued by companies but very different in behavior, risk, price and tax treatment.

Common stock is issued by a company, or similar entity, and represents an ownership interest or ‘share’ in the business. Public company stock prices are dictated by the public market or exchanges in which the shares are traded. If the overall stock market believes the company is worth more than it is traded for, additional purchasers will enter the market and the price of the stock will rise, and visa-versa. Common stock can pay a dividend, which means by holding a share of the stock, the company will reward you by paying a specified dollar amount per share, usually quarterly. Common stock is usually very liquid, but this depends significantly on what exchange the security is listed on and the nature (market cap, country, etc) of the company. For example, shares of a top industrial company on the NYSE are very liquid (or can be bought and sold freely), however a fledgling technology company trading OTC (over the counter) can be very difficult to buy or sell. Limit orders should always be used when buying or selling illiquid stock to avoid significant differences between the quoted stock price and the execution price. Price appreciation of common stock is almost always taxable unless held in a tax deferred account. In contrast to bonds, common stock is very low on the capital payout structure, meaning that if the company goes bankrupt, there is a much lower possibility of receiving any compensation for your ownership of shares. With bonds, there is usually a higher probability of being paid out a portion of your investment. More about bonds below…

Corporate Bonds are debt securities issued by a company usually in increments of $1,000 or ‘par value.’ Typically bonds are issued with a fixed or variable coupon, and a maturity date. A bond’s coupon refers to a payment (usually semi-annual) and is the ‘interest’ the company is paying you to borrow your money. The maturity date is a point in time in the future when the company has agreed to pay you back the par value of the bond. Some bonds have a call provision, which means that they have the ability to ‘mature’ the bond earlier than the stated maturity date, at which point you will receive the par value (or call price, which is sometimes different) of the bond sooner. Corporate bonds are also traded in the market but tend to be less liquid than most common stock. Even if the par value of a given bond is $1,000 a bond can be purchased for more, or less than the par value as dictated by the market prices. If you buy a bond for more than $1,000 you are paying a ‘premium,’ if you buy it for less you are purchasing the bond at a ‘discount.’ Premiums and discounts have an effect on the overall income stream (yield to maturity) you will receive during the time you hold the bond. Coupon rates also influence the yield to maturity of the bond, for example a 1% coupon bond will have a lower yield to maturity than a 6% coupon bond if bought at the same price. Yield also affects the duration (or price sensitivity to interest rate changes), the higher the coupon, the shorter the duration. Bonds are typically higher on the capital payout structure which means if a company defaults or goes bankrupt, there is a higher chance you will receive some or all of your investment back. Of course, this assumption also depends on if the bond is secured, unsecured, senior and many other variables. Corporate bonds are typically taxable.

There are far more differences between stocks and bonds but the above should be a good starting point. Always speak with your financial advisor prior to making decisions, as there are always securities that will fit your individual unique situation best.

** The information provided should not be interpreted as a recommendation, no aspects of your individual financial situation were considered. Always consult a financial professional before implementing any strategies derived from the information above.

Comment   |  Flag   |  Feb 01, 2012

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In the most simple terms: A stock represents ownership of a company. A bond represents an obligation of a company that has borrowed money from you and has an obligation to pay you back with interest.

2 Comments   |  Flag   |  Jan 12, 2012 from Arvada, CO
Gregory Werlinich, MBA

In addition, a bond has almost always has a maturity date at which time it returns to you the principal amount it borrowed. Bondholders are also higher in the pecking order of creditors than stockholders in the event of a bankruptcy.

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Flag |  Jan 13, 2012 near Port Chester, NY
Evan M. Levine, ChFC

Stockholders are " owners" Bond holders are " loaners"

Flag |  Jan 13, 2012 near Port Washington, NY

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They're actually more different than most people realize. Both are contracts that entitle the owner to something, but that "something" is very different for each.

A bond, or fixed income security, entitles an owner to a fixed stream of payments denominated in a currency over a specified period of time. It is an agreement or a promise to deliver a specific amount of money.

A stock, or equity security, entitles the owner to a share of the assets of a corporation. These assets may produce income in dollars or they may not. They can be valued in dollars, but equities of companies with operating assets are not dollars or money themselves. For example, if I own equity in a shoe factory, I own a share of the factory, which has tradable monetary value, but is not money itself. I have ownership of the physical structure and its productive capacity to turn raw materials into finished products.

People who invest in stocks often mistake the market value of shares in their investment account as money just like in their bank account, but in actuality when you purchase shares of a company, you don't have money anymore you have ownership of an asset. If you bought an apartment building it would be clear to you that you have exchanged money for an asset. With shares of a company it is the exact same thing. The only difference is that Wall Street brokerages show you the tradable market value of the shares in your account on a daily basis if you choose to look at it that frequently. This can cause you to feel irrationally wealthy in a bull market, and like you are losing money in a bear market. These are psychological tricks to get you to trade in your account more frequently than you need to. The value you see in your brokerage account is only marginally related the real value of the assets you hold.

The other crucial similarity between stocks and bonds is that they are both savings mechanisms. They are ways for you to store the wealth that you have accumulated from working hard and transfer its purchasing power to a later date. They accomplish this in very different ways though. Depending on the price that you pay for each contract and the current investment environment, one can be riskier than the other. It's not always a fixed proposition as to which one is the riskier one though.

Comment   |  Flag   |  May 10, 2013 from Santa Monica, CA

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