What are the advantages of common stock over bonds?
Stocks offer an opportunity for higher long-term returns compared with bonds but come with greater risk. Bonds are generally more stable than stocks but have provided lower long-term returns. By owning a mix of different investments, you're diversifying your portfolio.
With risk comes reward.
Stocks, on the other hand, typically combine a certain amount of unpredictability in the short-term, with the potential for a better return on your investment. According to CNN Money, large stocks on average have returned 10% per year since 1926 vs. a 5–6% return for long-term government bonds.
On the upside, preferred stocks usually feature higher yields than common dividend stocks or bonds issued by the same firm. Their dividend payments also take priority over those attached to the company's common stock dividends. If the company faces a cash crunch, common stock dividends get cut first.
Therefore, common stocks are less expensive and more practical alternatives against debt investment. One voting right is vested to an investor per share of each common stock held. These voting rights help investors to take part in business decisions and the creation of corporate policies.
Common stock tends to outperform bonds and preferred shares. It is also the type of stock that provides the biggest potential for long-term gains. If a company does well, the value of a common stock can go up. But keep in mind, if the company does poorly, the stock's value will also go down.
Stocks offer ownership and dividends, volatile short-term but driven by long-term earnings growth. Bonds provide stable income, crucial for wealth protection, especially as financial goals approach, balancing diversified portfolios.
The biggest difference between stocks and bonds is that with stocks, you own a small portion of a company, whereas with bonds, you loan a company or government money. Another difference is how they make money: stocks must grow in resale value, while bonds pay fixed interest over time.
Pros | Cons |
---|---|
Voting rights | High volatility |
Higher capital gains potential | Higher capital risk |
May be paid dividends | Dividend payouts are not guaranteed |
Other potential risks of owning common stocks include lack of diversification, foreign exchange, interest rates and country and company-specific issues. Many investors buy exchange-traded funds (ETFs) to diversify their common-stock portfolios more easily.
Pros | Cons |
---|---|
Regular dividends | Few or no voting rights |
Low capital loss risk | Low capital gain potential |
Right to dividends before common stockholders | Right to dividends only if funds remain after interest paid to bondholders |
What are disadvantages of common stocks?
For common stock, when a company goes bankrupt, the common stockholders do not receive their share of the assets until after creditors, bondholders, and preferred shareholders. This makes common stock riskier than debt or preferred shares.
Compared to preferred stock, common stock's profit potential tends to come more from growth in share price over time rather than dividends. Common stock has higher long-term growth potential than preferred stock but also has lower priority for dividends and a payout in the event of a liquidation.
- Advantages: Safety and low risk, thanks to backing of U.S. government.
- Disadvantages: Limited growth potential and prices will fall if rates rise.
Stocks provide greater return potential than bonds, but with greater volatility along the way. Bonds are issued and sold as a "safe" alternative to the generally bumpy ride of the stock market. Stocks involve greater risk, but with the opportunity of greater return.
While stocks have performed better than bonds in the long run, stocks are also more volatile and can experience more dramatic losses than bonds. These price swings can rattle investors and cause them to exit positions early. Bonds are typically more stable than stocks during economic uncertainty.
Therefore, investors looking to hold equities but not overexpose their portfolio to risk often buy preferred stock. In addition, preferred stock receives favorable tax treatment; therefore, institutional investors and large firms may be enticed to the investment due to its tax advantages.
A stock is an investment in a company. Your investment (purchased in shares) can grow or decline based on the company's success. A bond is an investment in a company's or government's debt. After you purchase a bond, the entity develops a plan to repay the principal of your investment with interest.
They provide a predictable income stream. Typically, bonds pay interest on a regular schedule, such as every six months. If the bonds are held to maturity, bondholders get back the entire principal, so bonds are a way to preserve capital while investing. Bonds can help offset exposure to more volatile stock holdings.
The potential benefits of investing in stocks include: Potential capital gains from owning a stock that grows in value over time. Potential income from dividends paid by the company. Lower tax rates on long-term capital gains.
Stocks are much more variable (or volatile) because they depend on the performance of the company. Thus, they are much riskier than bonds. When you buy a stock, it is hard to estimate what return you will receive over time (if any). Nonetheless, the greater the risk, the greater the return.
Which have higher returns on average stocks or bonds?
In general, over longer time periods, like seven or more years, stocks average the highest returns with corporate bonds, government bonds, and cash with the lowest annual performance.
Historically, bonds have generated stronger risk-adjusted returns compared to stocks in the three years following Federal Reserve tightening cycles. After the past seven tightening cycles, bonds delivered 89% of the return of stocks with only 26% of the volatility with more consistency in their range of outcomes.
- The right to vote.
- The receipt of dividends.
- A residual claim to assets at liquidation.
- Preemptive rights - the rights to purchase newly issued stock before it is available to others.
In general, stocks are riskier than bonds, simply due to the fact that they offer no guaranteed returns to the investor, unlike bonds, which offer fairly reliable returns through coupon payments.
Technically, yes. You can lose all your money in stocks or any other investment that has some degree of risk. However, this is rare. Even if you only hold one stock that does very poorly, you'll usually retain some residual value.
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