The Advantages of Debt vs. Stock
Investors have a choice between two major asset classes in financial securities. Stock, or equity investing, is ownership in corporations, and stock investors participate in the gains and losses of these companies.
Bonds are the debt of governments and corporations and provide investors with another investment avenue. For many investors, bonds have certain advantages over stocks that make them attractive.
A primary reason to invest in debt or bonds is to earn a steady, known income. Most bonds pay a fixed rate of interest until the bond matures.
An investor who needs a certain level of income can lock in that income by buying enough bonds to produce the desired income. Stock dividends are not guaranteed, and a company can change or stop them at any time.
Return of Principal
As a debt investment, owning bonds entitles the bondholder to have the principal or face amount of the bond returned when the bond matures. Bonds can be purchases with maturities ranging from a few months out to 40 years.
The future value of any stock is unknown and can be affected by company results and market conditions. If a company goes bankrupt, stock owners are wiped out, but bondholders have a claim on the company’s assets.
Price and Yield
The price and yield of bonds are linked together, allowing investors to make decisions based on where they think interest rates are going. If rates are falling, investors can buy long-term bonds and the market value of the bonds will increase as the rates fall.
In a rising rate environment, investors can buy short-term bonds and reinvest when the bonds mature at the new, higher rates. Stock investing does not offer this opportunity to invest based on changing interest rates.
High-yield bonds, or junk bonds, sometimes offer a unique opportunity compared to buying stock in a specific company. High-yield bonds will pay a high rate of interest and if the financial condition of the issuing company improves, the market value of the bonds will increase on the favorable news.
Junk-bond investors earn interest from the company while the stock investors may not be paid anything.
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