The age-old question of whether one should invest in stocks or bonds is still the most important issue when taking positions in the financial markets. Both stocks and bonds offer investors advantages and disadvantages, and depending on what your outlook is on the economy, that should help dictate which market to invest one’s capital. Many folks ask the question, which security is better? And the answer every time is, neither, as each market has its pros and cons, offering different return and risk.
Let’s start with stocks. Stocks are equity securities that offer investors return on their capital with generally a higher level of risk. Stocks are a form of ownership, as they represent an investment and participation in a company’s growth and strategic outlook. There are many types of equity investments one can make these days in the form of ETFs, individual stocks, sector plays, and mutual funds. Investors have no guarantees on return on capital, and there is always a risk to an investor’s principal when buying equities. There are all sorts of stocks to invest in, and the type will determine the level of risk.
For instance, a stock with a high beta, which measures the volatility of a security in comparison to the market as a whole, tends to fluctuate more, offering higher returns but containing more risk. The more popular and prudent investments since the real estate bubble popped in 2008 are big-cap dividend paying stocks. This particular group offers investors a dividend yield greater than what folks would earn at their local bank. Moreover, many of these companies have cut their debt and increased their cash position, providing investors with a strong balance sheet and improved solvency ratios. Equity securities such as Verizon and AT&T have been popular picks in this economic environment, as these two stocks pay participants around 5.00 percent on their money while they wait for appreciation.
Dividends have been the key to many stocks doing well in today’s market as investors remain on the hunt for yield. With interest rates so low, investors are parking their cash in securities that offer a decent return and are simply waiting and not selling despite there being quite a bit of volatility. Dividend-paying stocks across all sectors have been performing well, as utilities and REITs have been offering investors great returns when compared to Treasury securities. Equities in general are more risky, but considering the economic environment, dividend payers have been very stable and tend to be gobbled up on all dips.
Bonds, on the other hand, are a form of debt with which you are the lender instead of the borrower. Bonds are contractual loans made between investors and institutions, where interest and term (length of time) are mutually agreed upon. The investor receives their principal back at the end of maturity, and their return is based upon the coupon payments received and whether the bond was purchased at a discount or premium. The payment of the company’s coupon is dependent on the company’s sales and the ability of the borrower to generate enough cash flow to repay bondholders. Many older folks who do not have a steady income prefer the bond market as it offers a periodic income of coupon payments that many rely on.
In the bond market, treasury securities offer a very low yield, with the ten-year currently paying 1.61 percent to investors. Most folks are not putting their money to work in Treasuries due to their low yield and would comparably opt to place their money at the local bank in a savings account. After all, savings accounts at most banks are offering around 1 percent and are FDIC-insured up to $100,000 – it makes sense. That said, one area that has been a very popular place for investors to put their money has been the high-yield bond market.
High-yield bond issuance has broken every record this year as companies are very tempted to issue debt at lower rates, and folks are more than happy with the returns. High yield companies generally yield slightly over 5.00 percent, so those companies with good cash flow, solvency ratios, and sales strategy are very attractive investments. There are many ways for the ordinary retail investor to participate in the high-yield bond market, either through individual buying, high-yield bond funds, or the ever-popular Barclays ETF (JNK). So far high-yield bonds have yielded 12 percent or better due to high coupon payments and demand for these issues which is forcing prices higher in the secondary market.
The battle between whether stocks or bonds are a better investment mainly depends on your risk profile. In general, younger folks tend to buy stocks and older folks purchase bonds. Since the crisis there has been a good mix amongst all age categories, as frankly a combination of the two is the best strategy. By diversifying one’s investments and putting some money into both stocks and bonds, folks have some safety while striving for above-average returns.
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