What is a stock and a bond?
The terms ‘stocks’ and ‘bonds’ are frequently used when discussing investment options. They are often lumped together but they are actually very different.
While you might not need to know all the specifics, as a new investor it’s important to have a general idea of each in order to make decisions about how you want to invest your money.
Let’s start general
Stocks and bonds are types of ‘securities’ — that is, a tradable financial asset.
In another one of our articles, we used the visual of ‘luggage’ to describe a portfolio: you pack your luggage with things that you need based on where you want to go.
In the same way — you ‘pack’ your portfolio with securities like stocks and bonds based on your investment strategy and plan.
Stock is a way to buy into the business and you therefore own a portion, referred to as a share, in the business. Maybe you have heard of the term ‘shareholder’ — this is where it comes from. Depending on your investment arrangement, your ownership may entitle you to voting rights, for example, on business and/or management decisions.
You buy a stock on the expectation that the business will grow and make a profit. As the business grows, your stock therefore becomes more valuable. Then, when you sell your shares at a later date, you can expect to get back more money than what you initially put in.
Bonds, on the other hand, are a way for you to lend money to the business and you charge interest. So, for example, if you invest 1,000dkk (the principal amount), with an interest rate of 10% for 10 years, you will receive back interest payments from the business (known as coupons) of 100dkk. These are generally paid to bondholders every six months. At the end of the agreed period (the maturity date), the business must repay the principal (1000dkk) back to you. So on top of getting your initial investment back, for the last 10 years you have earnt 2000dkk.
The associated risks
If a business does not make a profit and eventually has to close down, they have a legal obligation to repay bonds but not stocks. Because of this, bonds are considered less risky than stocks. However, if the business goes well, shareholders (people who own stocks) are likely to get a higher return than people with bonds since the agreed interest rate doesn’t change.
This is why it is important to consider the prospects and sustainability of the business or industry that you invest in. There is a lot of information about sustainable investment and impact investing to consider online to help you make an informed decision.
For example, the traditional, fossil-fuelled car industry is predicted to decline in the coming years due to concerns about emissions. It is also suggested that if electric and hybrid vehicles become widely available, consumers will opt for these options, implying that this could be a strong growth industry.
As with all aspects of investing, deciding whether to buy stocks or bonds depends on your investment strategy. Most portfolios are made up with a mix of securities (bonds, stocks and others). This ‘diversification’ is a way for investors to strengthen their investments as it balances the risk associated with investing.
Kate Harris is a copywriter at MakeImpact, a Nordic Impact Fintech that helps individuals make sustainable investment decisions through their values.
