Common stocks and bonds are two types of securities a company issues to investors to raise money for its business. Both securities give an investor a financial stake in the company, but there are differences between the two that can lead to varying levels of performance in your portfolio. Understand the characteristics of each to help you make solid investment decisions.
A holder of common stock has an ownership interest in a company and a partial claim on the company’s profits. She also has the right to vote on certain company decisions, such as electing a board of directors. While a bondholder has no ownership interest or voting rights in a company, he receives priority in getting paid before stockholders if the company files bankruptcy and liquidates its assets.
When a company sells bonds to investors, it agrees to return the initial investment on the bond’s maturity date. Stockholders receive no such guarantee and could lose their entire investment if the company suffers financial trouble. The return of your initial investment and the priority in bankruptcy make bonds a lower-risk investment than common stocks. The higher risk of stocks comes with more potential reward, though, in the form of price appreciation as the company grows its profits.
Some stocks provide an income stream to stockholders in the form of dividends — a distribution of the company’s profits. Dividends can add to the return on your investment. A company may pay dividends periodically, such as annually or quarterly, but is not obligated to pay dividends at all. A company that wants to conserve its resources may reduce or eliminate its dividend, while a company that is growing its profits may increase its dividends.
Unlike dividends from stocks, a bond that pays interest makes fixed payments for the life of the bond, providing the bondholder a steady income stream. A bond makes interest payments periodically, such as semiannually or annually, based on the bond’s coupon rate. A company with a higher risk of default — the failure to make interest payments or failure to pay back the initial investment — pays a higher rate on its bonds.
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