What are the differences between Bonds Vs Stocks and what really are they. The following article provides a simplified answer to these questions and more.
Bonds and Stocks defined:
Stocks: A stock is a type of security that represents ownership in a company. With stocks an investor is investing in a company.
Bonds: A bond is an investment that represents a debt by a company or government. With bonds an investor is loaning the entity money.
Differences between Bonds and Stocks:
The primary difference between stocks and bonds is the how an investor participates in funding the entity. With stocks an investor is taking ownership and therefore participating in the growth of the company, or its demise. With bonds an investor is lending the entity money at set rate of return and duration and does not participate in the growth of the entity, but does take precedent over stockholders if the entity fails in a bankruptcy preceding.
From a risk difference, bonds typically represent a less risky way to participate in the marketplace especially in a deflationary period, such as a recessionary period in the economy. In a highly inflationary period, such as an expansion in the economy, stocks typically provide the best way to keep pace with the growth.
Bonds Vs. Stocks
Today stocks are mainstream but not long ago bonds where the only place to be. Risk tolerance in the market determines whether stocks vs. bonds are in favor. When we look at any cycle in a market it is important to understand these cycles act much like price action, where even though a market is expanding or shrinking, it is never in a straight line. Markets breath, meaning that if they are expanding they take two steps forward and one step back. If a market is shrinking it takes two steps back and one step forward.
Stock and Bond cycles have breath, for example even if stock ownership was on the rise it would still cycle from stock ownership expansion to bond and back but stocks would outweigh bonds 2 to 1. The same could be said if bonds were expanding in ownership it would cycle from bonds to stocks and back again, but bonds would outweigh stocks 2 to 1.
From all of the above, we should be able to see how the cycle between stocks and bonds is a good indication of what types of economic pressures exist on investors. A bond investor is looking for a fixed outcome where a stock investor is making a bet on the future or an assumption of an expanding economy.