Explain stocks and bonds

The difference between stocks & bonds 2021 - explained for beginners

What is the difference between stocks and bonds? We simply summarize the differences and compare the opportunities and risks of the two types of investment.

What are stocks?

Shares certify joint ownership in a company. Shareholders represent a companyEquity available and receive company shares in return.

As shareholders in the company, you have the following rights:

  • The right to a share in the Distributions the company
  • The right to information to develop the company
  • The right to Liquidation proceeds in the event of bankruptcy

A company can choose to distribute funds to shareholders. This is called "Dividend" designated. However, there is no entitlement to this. Even if a company is making balance sheet profits, it can suspend dividend payments and save or reinvest the capital.

What are bonds?

Bonds certify you obligation under the law of obligations to a company, state, city or municipality. Buyers of a bond grant the company that issued the bond a loan and receive the right to regular interest payments as well as the repayment of a fixed "nominal value" or "nominal value" at the end of the term.

The company pays one annually, semi-annually, or quarterly for its bond pre-determined interest rate ("Coupon"). In contrast to dividends, the level of interest is independent of its economic situation. As long as it is not insolvent, it is obliged to make regular interest payments.

What are the main differences between stocks and bonds?

The most important differences arise from the fact that shareholders and bondholders have different business relationships with the company. Shareholders own company shares and thus have a Say, that bondholders who have only given outside capital have to do without.

The dividend is flexible and can also be reduced to zero while the Interest on bonds are usually firmly agreed. They cannot be suspended even if a company is threatened with bankruptcy (be careful, clauses in the bond contract can change that).

Unlike stocks, bonds have one fixed term, at the end of which the bondholders receive an agreed sum. Shareholders, on the other hand, find it difficult to estimate how much money will be made in the future by selling a share; the prices of most stocks are volatile and react to numerous economic and political factors that are difficult to predict.

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Are bonds “safer” than stocks?

The price of bonds tends to be less volatile than that of stocks. If you want to hold a bond until maturity, you don't even have to worry about its price, but only about the creditworthiness of the issuing company. Because of this, and because of the fixed interest rates, bonds offer one better predictability in investing. Many financial advisors therefore recommend investing more in bonds and less in stocks as you get older. Explanation

Why are bonds less volatile than stocks?

The lower susceptibility to fluctuations is due to the fact that in the first place two factors have an impact on the value of bonds: The general level of interest rates and the likelihood of bankruptcy of the company that issued the bond. If the company can pay by the due date, bondholders know exactly how much money they will receive.

The price of stocks, on the other hand, reacts to all factors that have an influence on thefuture profit expectations of a company because the potential dividend payments depend on it. As you can easily imagine, the creditworthiness of a company at a given point in time is much easier to forecast than the profit expectations in the short, medium and long term.

In addition, investors can use bonds to make their money available to states, many of which - such as the German state - are classified as particularly "fail-safe" be valid.

Another argument in favor of the security of bonds is that the holders of common bonds im Bankruptcy case before the shareholders to be served. However, it is just as possible that if the company is in difficulties, discounts or a waiver of interest can be agreed with the bondholders in order to prevent bankruptcy.

The important thing is: both stocks and bonds can fail, if the issuing company goes bankrupt. For both asset classes, the risk of insolvency depends on the issuer. For example, there are bonds known as “high yield bonds” or “junk bonds” that combine high interest rates with a significant risk of default.

As with stocks, aSpread over many titles reduce the risk of losses from default, while focusing on a few bonds can be dangerous.

Investors should also be aware of another risk: in the current phase of low interest rates, many bonds from countries and companies that are considered to be “safe” are yielding below the level of inflation or even negative. The protection against failures must therefore with a creeping Loss of purchasing power get paid.

Has the corona crisis changed anything in the risk-reward ratio of stocks and bonds?

No, the 2020/2021 corona crisis has existing opportunities and risks rather reinforced, than to fundamentally change them.

The corona pandemic started on the stock market massive price drops, which was mainly due to the unpredictability of its consequences. As the situation became more manageable, however, the stock market recovered and many indices reached higher values ​​than before the pandemic.

So the corona situation had become one Increase in opportunities and risks led by stocks: Those who invested during the price crashes were ultimately able to achieve good returns. At this point in time, however, it was not yet possible to foresee when and to what extent the prices would recover.

In the case of bonds, events were divided. Many bonds rated as "safe", such as federal securities and other government bonds, increased in value and thus offered fewer opportunities for returns.

In the case of "junk bonds", i.e. bonds from companies with poor credit ratings, on the other hand, prices fell. Investors expected a greater risk of default in unstable companies, so that higher interest rates had to be offered as a risk compensation even for new issues.

Conclusion

Bonds tend to havelower risk of loss than stocks and more predictable income. However, these are offset by lower return opportunities.

You cannot blindly rely on the “security” of bonds, because there is something in the bond market toorisky and even dubious offers. In addition, the “typical” properties of bonds (they have to be returned by the due date, are at the top of the bankruptcy order, etc.) can be changed through contractual clauses.

If investors don't want to experience a nasty surprise,you should understand before making any investment to whom they make their money available and under what conditions.

Risky combination products: reverse convertible bonds

Reverse convertible bonds, which are also known as "reverse convertible bond", are mostly used from banks issued. As with normal bonds, the company pays fixed interest payments.

How much owners receive at the end of the term is dependent on the company's share price. When the bond is issued, a "base price" is set. The share price is compared with the base price on a certain day, usually shortly before the share's maturity.

If the share price is at or above the base price, the holder receives theFace value of the bond. If the share price is below the base price, he only receives the equivalent of a specified number of shares or the shares themselves.

Reverse convertibles usually advertise particularly attractive interest rates, which, however, come with corresponding risks. If the company is developing well, Investors do not benefit from the rising prices. You will receive at most the interest payments and the face value of the bond.

If, on the other hand, the company gets into stormy waters, investors involuntarily become shareholders and thus find themselves in a position that particularly sensitive to turbulence of the company reacts. You will likely have to take losses first with no assurance that the stock price will recover over the long term. Some critical experts therefore even claim that reverse convertibles combine the disadvantages of both forms of investment.

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