Difference Between Stocks & Bonds

By December 7, 2018 Blog No Comments

Sometimes finances can be a little crazy. It can be a little intimidating to start delving into the monetary world for those of us who may not be so financially savvy. And sometimes the terms seem as if they should mean the same thing but they do not. Or perhaps they sound completely different and you are left feeling like a baboon who has been told to solve the equation for transporting matter onto a moving spaceship.

So how does one get started in this world? There are a few terms that come up fairly often when one begins a trip into investment land. Stocks and bonds are two such very popular terms. We always hear about people who seemingly make millions from trading stocks. And of course, who can hear the word “bond” without thinking about war bonds issued during WWII? Well, here are a few basic definitions with which to begin your journey.

A bond is a little bit different than a stock. Essentially, one might think of a bond as a sort of loan to a corporation or sometimes even the government. With a bond, it is expected that the receiver of the “loan” will pay it back at some set, future date. Bonds are used to help corporations, or as mentioned with war bonds, governments fund special projects. One way in which governments can and do raise money is to sell bonds to its people. World War II saw millions of American citizens forking over quite a bit of money to the United States government to purchase bonds to help fund the war.

According to the WWII National Museum website, the war cost the government more than $300 billion dollars, which is well over $4 trillion after adjusting for inflation. As explained by the museum’s bond page, citizens would buy, for example, a $25 bond for about $18. Within the decade that would be repaid to the citizen who purchased it, at face value: $25, and thus, the citizen in question would make about $7 on their investment. So a bond is an investment in one’s future. And of course, during World War II, patriotic propaganda ran high, encouraging anyone and everyone to buy war bonds. Naturally, many people bought multiple bonds to fulfill their patriotic duty. If one bought ten bonds, that would turn a nice $70 profit in just a few years. Adjusting again for inflation, this would be about $112 in profit per bond, or $1,100 for those ten bonds in 2016.

Now, what about stocks? A stock, according to Merriam-Webster Dictionary, is “a share of the value of a company which can be bought, sold, or traded as an investment.” Or in even simpler terms from AccountingCoach: “stocks represent ownership interest in a company.” That company is selling a part of itself to raise money. A stock means you have a share in a company, a piece of the pie, if you will. This is especially a good thing if you own stock in an exceptionally innovative company which pays dividends. A dividend means that you’ll get money back for your investment in that company every quarter. A dividend is also a fairly good indication that the company in question is doing really well. When a company pays back its investors with dividends, they’re saying they have so much extra money that they actually cannot find enough projects to funnel that money back into.

According to Investopedia, “Issuing stock is advantageous for the company because it does not require the company to pay back the money or make interest payments along the way.” A bond on the other hand, accrues interest as time goes on. Stocks pay out extra, or leftover money, to their investors. Stocks can be a little bit riskier course of investment for this reason. One can never be quite certain how much or even if your investment into a company’s stock will pay off in the long run. Bonds, however, have set amounts, such as the war bonds example above, and are paid back with interest. Bonds also often have set payment dates, just like those housing or student loans looming over your shoulder.

For this reason, bonds are a solid investment. With stocks, it’s frightfully easy to lose millions of dollars; just go ask anyone involved in the Dotcom bubble bust of the 90s when a whopping $5 trillion dollars was lost. Entrepreneurs desperate for cash promised these investors unrealistic returns, but were unable to fulfill those promises, and so many dreams died and those trillions of dollars were lost. Or even think of the great stock market crash of 1929, when stocks were far overvalued, production fell, and so did profits. People panicked and tried to sell every stock they had to save some of their wealth, only to suddenly find their stocks sold of only a minute fraction of their original value.

In conclusion: stocks mean you own a little bit of a company and you may or may not make a profit. Bonds are a sort of long-term loan in which you will make a nice healthy return.

About Woven Capital

Aaron Hatch is a Certified Financial Planner and co-founder of Woven Capital, a fee-only financial planning and investment management firm that specializes in helping people balance life, work, and community. Aaron has been quoted in various publications, including The Chicago Tribune, US News and World Report, and the Huffington Post among others. Aaron can be reached at aaron@wovencapital.net