Publicly traded companies can raise capital by issuing stocks and bonds. Both shareholders and bondholders may earn income from their investments, but they have different rights and responsibilities. While both parties want the company to thrive, they tend to have conflicting interests. Here's what you should know about investing in stocks versus bonds so you can make an informed decision.
Shareholders own a piece of the company they invest in and may have voting rights. Bondholders, on the other hand, lend money to the company and earn interest on the principal amount.
Companies issue stock to get the money needed for launching new products, paying off debt or expanding their reach. Investors buy stocks, or shares, to make a profit. This entitles them to partial ownership of that company, explains the Office of Investor Education and Advocacy (OIEA). Depending on the type of stock, they may also have the right to vote, see corporate records, elect the board of directors and receive dividend payments.
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Shareholders have the option to invest in common or preferred stock. If you buy common stock, you'll receive voting rights and earn dividends. The dividends are variable, meaning that you will earn more or less depending on the company's profits. Preferred stock, on the other hand, does not give you voting rights, but you'll still receive dividends. In this case, the dividends are fixed and cumulative, according to Corporate Finance Institute.
Another aspect to consider is that preferred stockholders are paid out first. Therefore, they are less likely to lose their money if the company goes bankrupt. Common stockholders are paid last. Bondholders, however, will always have priority over shareholders. Preferred and common stocks can be further divided into several categories, such as growth stocks, value stocks, income stocks or blue-chip stocks.
From an investment perspective, stocks are generally more profitable but riskier than bonds. Their prices can fall in the blink of an eye, forcing investors to sell their shares below their full value. In the worst-case scenario, they may end up losing everything they invested. On the positive side, stockholders may have the right to transfer ownership, attend meetings or even sue the company. They also have access to its financial documents, which can lead to smarter investments and better decision-making.
Unlike shareholders, bondholders don't have ownership or voting rights. These investors lend money to the company issuing bonds, which allows them to earn interest. Organizations may use the funds to develop new products, buy equipment, pay shareholder dividends and so on. Bonds are less volatile than stocks and other securities, offering a predictable stream of income.
These financial instruments may include high-yield bonds, corporate bonds, municipal bonds or investment-grade bonds. Treasury bills and notes fall into this category, too. Investors can either hold the bonds and collect interest on the principal amount or sell them for profit. While they are in a more secure position in the event of bankruptcy, they may also earn lower returns than stockholders. For this reason, it's best to have both shares and bonds in your portfolio.
As mentioned earlier, shareholders and bondholders often have conflicting interests. For example, stockholders are the last to be paid during the bankruptcy process. This aspect alone can result in conflict. There are also cases where shareholders and bondholders don't agree on the company's strategy. Since stockholders have voting rights, their decisions can affect a company's bottom line and negatively impact bondholders. The use of protective bond covenants can help prevent or solve these issues, explains NASDAQ.