Traditionally, the returns earned on bonds are more modest than those achieved in the equity markets. Bonds are often relied upon as safe and steady investments, while stocks, which belong to the equity asset class, have a tendency to trade with greater volatility. Although the returns that may be earned with stocks can be rewarding, the losses that equities may trigger can be damaging.
Stock returns can be unpredictable. Equities do not always trade on fundamentals, such as profits and earnings, but instead are subject to investor sentiment, such as fear or exuberance. Many stocks generate the greatest returns during the debut session, known as an initial public offering, of IPO, though that not always the case. According to the CNBC website, LinkedIn's IPO delivered returns of 109 percent during its first day or public trading. Conversely, the FriendFinder Networks IPO was punished with a decline of more than 20 percent during its first session.
The return on bonds is based on the price paid for the debt security and the interest rate attached to the investment. Bond investors continue to earn income from the security until the contract matures. The face value represents the price paid for the bond, and this value is returned to an investor when the contract expires. If an investor is able to buy a bond for less than the face value of the contract, the yield or return on the investment increases. According to the Smart Money website, it is not uncommon for bonds to sell below the face value.
According to the Bond Desk Group, bonds are a compelling investment option compared to equities on an historical basis. In the nine-year period beginning in 1989, bonds generated returns of 7.6 percent, which was lower than the 10.4 percent returns that equities delivered, but investors had to manage greater volatility in stocks over the period. Stock volatility was measured at 20 percent while price swings in bonds were estimated at 5.3 percent in the period.
Certain bonds are riskier than others are. High-yield bonds hold the promise for greater returns versus more traditional debt securities but they also pose a greater risk of default. According to a 2010 article on the CNBC website, both equities and risky bonds were expected to deliver lower-than-average returns in the foreseeable future. In fact, bond investor Bill Gross of PIMCO warned investors to slash return expectations for stocks and risky bonds by approximately 50 percent and to accept this performance as the new normal.
- Jupiterimages/Photos.com/Getty Images