You may know there is a difference between corporate bonds and stocks and you may know it’s good to hold both stocks and bonds, but beyond these simple rules, do you understand how it all works? At the simplest level, stocks give investors part ownership in the business based on the number of shares they’ve bought. Bonds put money in investor’s pockets to finance business operation. It’s akin to a short-term loan made to the company by the bond buyer. Bonds pay interest over time, though they can also be traded. Stocks are sold on the market and pay at the time of sale, though they can increase and decrease in value; no return is guaranteed. Dive deeper into the corporate bonds vs. stocks to understand the differences.
What Are Corporate Stocks?
Corporate stocks offer equity or ownership stakes in the business in the form of shares. Let’s say the share price is $10 and you purchase 100 shares of a stock. This would cost you $1,000 up front. Let’s say the stock doubles in a 12-month period to $20 a share and you decide to sell your shares. You gain $2,000 from your $1,000 investment, and now you have $2,000 in cash to invest in another stock.
While most people refer to them as “stocks,” they’re also called “shares” or “securities.” You’ll often see the term “equity” paired with “stock,” “share,” or “security,” — equity shares, equity securities and the like.
Before you get excited to shop for stocks, remember that you can only buy stocks of public companies, such as a company that has filed an S-1 IPO filing form in order to conduct an initial public offering, better known as an IPO.
It can be tempting to purchase shares during an IPO to be one of the first to own a new stock. Rather than buy based on newness, always do the due diligence to explore whether the stock pick is a strong one before you invest.
What Are Corporate Bonds?
Corporate bonds are essentially IOUs issued by the business to corporate bond buyers. Bond buyers lend money to the business through the act of buying a bond. The business pays regular interest to bond buyers. When the bond matures, they repay the debt. While we’re talking about corporate bonds, it’s important to note that governments also issue bonds and government bonds work in much the same way.
Let’s say a company issues $500 bonds with 2% interest that mature in 10 years. In 10 years, you’ll get your original $500 back. Between now and then, you will earn 2% interest per year, or $10 per year.
Companies use bonds to raise money for needed initiatives. From the corporation’s point of view, it is simpler and easier to issue bonds than to approach a bank and ask for a loan. Banks tend to place restrictions on loans, but companies can issue bonds without facing any restrictions.
How Are Corporate Bonds Rated & Priced?
If you’ve decided to invest in bonds, you should understand how they are rated and priced. This way, you can know exactly what you are buying. Bonds are rating in one of two ways: investment grade or speculative grade.
Investment grade bonds are subdivided into four tiers — AAA, AA, A or BBB — ranging from the highest quality to medium quality. High-yield bonds, or junk bonds, fall into the speculative category, which ranks bonds as BB, B, CC, C or D.
Just like academic grades, A is good and D is the market equivalent of needs improvement. The better the grade, the more stable the bond. The lower the grade, the greater the likelihood of default. However, these bonds come with higher yields to offset the extra risk.
Bond prices reflect the price you’ll pay to purchase the bond. Prices are set by a range of factors including the interest rates, the credit rating of the company whose bond you are buying and the maturity length of the bond.
Why People Invest in Corporate Bonds
Ultimately a diversified approach in which you own both stocks and bonds is best. Stocks are riskier due to volatility, but they can deliver big financial wins. Bonds are widely considered safer, but they offer lower returns; they tend to preserve wealth rather than generate it. By combining some of column A and some of column B, you win either way. The older you get and the more money you have, in theory, the more money you’d want to move from stocks into bonds, so you don’t lose that wealth right before you retire.
This is a simplified way of looking at it, but it helps explain some reasons people invest in bonds. Bonds diversify a portfolio of stocks, and they generate recurring income in the form of interest.
Are corporate bonds safer than stocks? Generally, bonds are generally seen as safe, but there are some risks to note. One is bankruptcy. If the company went under, they couldn’t pay you back. They’d default and you’d lose your investment.
Just as companies that are considering offering bonds might want to use a data room to organize their strategic process, investors shopping for investments will want to conduct due diligence before buying equities. Only when you’ve vetted the stock or bond on offer and feel confident with the risk you are taking should you make the trade.