If someone thinks of investing their money, it almost universally comes down to two major ways – either through equity or debt. Equity is where an investor becomes a part owner of the invested company or business. Whereas debt is the traditional lending and borrowing process. Here the investor acts as the creditor and the return is the interest plus capital. Interestingly, these two concepts are also what define shares and bonds. So, Shares or bonds, what is the best investment stream? And more importantly, what’s right for you? Let’s find out.
What are Shares?
A share is a unit of measurement for a stock, which is the actual asset in which you invest. Shares make up the basis of equity investment. Here the investor invests to become a part owner of the company. The size of the owner depends on the number of shares bought. It also depends on the number of shares in circulation by the company.
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At its core, an investor or shareholder utilizes the high-risk, high-return factor of share investment. For example, if the company consistently performs well, the shareholder will enjoy a consistently high ROI. On the other hand, if a company performs, poorly, it will lead to a loss of investment.
Shareholders receive dividends annually based on the profit margin of the company. Depending on the business cycle, this margin can be high or even so low that there might be no dividend at all.
If an investor holds a substantial share in a company, they get a place on the board of directors where they can vote to decide the future course of the company. Shares essentially allow an individual investor to take responsibility and the implications are also simple. You share the profit as well as the loss in an equal manner, hence the high risk, high return factor.
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Advantages of Shares Compared to Bonds
The main advantage of shares is the potential for high returns. Other investment opportunities can hardly provide a similar level of return possibilities. Shares also pay dividends which is another addition to lucrative profit margins.
The return on investment will grossly depend on the period of high profit or less. Since the instrument of investment for shares is equity, investors can expect proportional growth or loss on their investments. The same doesn’t hold for bonds.
Investors can input their ideas into the future process of a business with share investments. It makes for a more controlled and impactful investment compared to bonds.
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Disadvantages of Shares Compared to Bonds
The only disadvantage of shares compared to bonds are the high-risk factor. There is no way to understand how a business will perform given the volatile investment climate.
Every share is traded through a central stock exchange commission which may go through a gross fluctuation by the minute.
So if you’re risk-averse, chances are that shares aren’t really for you.
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What are Bonds?
You lend your friend a crisp 100-dollar bill and he pays you back 110 dollars the next month. The additional 10 dollars over the capital is the interest on top of the capital. Bonds follow this exact principle of debt instrument. Here the investor, who buys the bond, is the creditor, and the bond seller company or business is the debtor.
The investor (bond buyer) and the company (bond seller) essentially draw up a loan agreement. As part of the agreement, the company will pay back the invested sum within a certain date along with a regular fixed interest rate on top of the capital.
It's low risk with a low return but provides better security on the invested capital.
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Advantages of Bonds over Shares
The only advantage of bonds over shares is the low volatility. Unlike shares, bonds have a fixed return rate on top of the capital. Here, the investor knows upfront how much they will be getting out of the investment at the end of the cycle.
Even in case, the company goes bankrupt, the bond investors will get priority compared to the shareholders in returning the dues. As a result, the investments of bondholders are secured in both ways.
Disadvantages of Bonds Compared to Shares
The main disadvantage of bonds compared to shares are the reduced return and lack of equity. At the cost of security, bonds investor has to forego a substantial ROI generation. The bonds' investors do not get any say in the process and proceedings of the business which is otherwise possible with shares.
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Lifecycle of Bonds and Shares
Both bonds and shares have their respective lifecycles which are often important for an investor to understand which investment cycle works best for them.
A share has typically 4 phases in its lifecycle – accumulation phase, markup phase, distribution phase, and downtrend phase. Each of these phases comes up cyclically where the price stabilizes, goes up, shareholders sell and the price tumbles again.
The bond lifecycle is much more simple compared to the shares. Here there’s a primary market where the bond gets issued, a secondary market where the bond gets traded, and finally maturity, where the investors get back their capital.
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The companies can use the resolved bonds at maturity to venture into new refinancing opportunities.
Shares vs. Bonds – Which One is the Better Investment Option?
Shares and bonds are both great investment options. But the choice of investment depends much on what you want out of your investment.
If you want a high return and aren’t worried about the associated risks, go for shares. But if you are more concerned about the security of the investment and returns are your secondary concern, then head over to the bond market.
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Final Words
Shares and bonds are both equally popular as investment opportunities. The process of investing through shares usually requires a BO account in a brokerage firm. On the other hand, a bond requires an agreement drawn out through a third party, usually a bank.
Both stocks and bonds are protected by strict government financial regulation with the former having its separate regulatory commission. So depending on your preference, both shares and bonds can be an effective way to increase your wealth base.