In case the question on your mind is simply where you will earn more money, between bonds and stocks, this article is to evaluate that relationship and hopefully put the issues in perspective for you. Investing is a holistic process and smart investors seek to achieve a set of investment objectives that best advance their financial interest. At the end, it's probably about being in a stronger overall financial position, day after day.
Because the environment within which investments are made is affected by several variables, nothing is certain about the future. Many fortuitous things may happen that work to the advantage of the investor, while other occurrences may hurt his interest. An intelligent investment process is always recognising this reality and devising ways to ride these occurrences to best advantage, which may just be to limit their damage, when negative. That is what gives rise, for instance, to certain investment tools like options, futures, swaps, forwards or other derivatives, especially in developed markets. In deciding what gets into your basket of investments, that is also a major consideration.
Income Differences
To start with, bonds earn interest, while stocks are rewarded with dividends. For most bonds, that interest is fixed, thus giving a regular, steady stream of income. Besides, the interest is a binding obligation which the company has to meet, with a default opening it up to judicial remedial action. For stockholders, even when profit has been made, the directors may, out of prudence, for instance, choose that every kobo be re-invested and fail to recommend a dividend. The amount of dividend is therefore unknown and uncertain, though in one breath, this offers the advantage that there is no limit to how much that can be paid. So, between bonds and stocks, you may not only have differences in the amount of income, there are other differences as to regularity (not guaranteed for stocks), timing (bonds have fixed dates, stocks don't), and amount (unlimited for stocks).
So which will earn you more? With many factors at play, this cannot be guaranteed about the future. Historically, it can however be stated that stocks have averagely out-performed bonds in terms of earnings track record. Because stockholders are risk-takers carrying the burden of ownership interest which could spell total loss of capital if the business does not survive, they do deserve a higher return, should things work out well. That possibly explains the higher average returns on stocks. But this cannot be assured about the future and with respect to specific securities. When the stock market gets very bearish or suffers a crash, stockholders easily loss money. There, their returns will be negative. Bond holders will however remain entitled to their fixed income and repayment of principal (par value) at maturity. In such situation you are easily better off holding bonds!
It All Adds Up
Strategically, it's therefore not a question of which earns more. Between stocks and bonds, we are looking at two investment options with different features, which, instead of strictly creating a choice, rather widen your scope to structure your investment basket more efficiently. Winning in a change-driven market environment requires that you build cushions into your vehicle. Or better still, shock absorbers. That's where the concept of portfolio diversification comes from: spreading your assets in a way that draws on the strengths of various instruments to cancel out weaknesses in others and building a whole that is more formidable against the vicissitudes of the market. Simply put, bonds and stocks should play a complementary role in helping you construct a portfolio that can stand market stress and leave you reasonably comfortable. Otherwise, when spanked by the market, you may find yourself overwhelmed.
What to Do
Work to improve your investment strategies to recognise and deal with the contending and key variables of investing. The inverse relationship between risk and return should, for instance, be clear to you: most times, when you try to earn more, you wittingly or unwittingly expose your capital to more risk. How much risk to take should be by choice. As much as possible, though, deploy financial management tools that balance your interests and leave you with a stronger collection of investments - the so-called diversified portfolio. More advanced theory of risk and return tries to identify an efficient frontier which is where the ideal portfolio to hold lies, because it optimises your reward-to-risk ratio. The simple point about a balanced portfolio should, at least, have registered by now. To gain the benefits, you need a careful blend of various asset classes, selected to optimise income quantum and timing, capital growth and overall safety of investment.
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