Forex in this article
indices in this article
• A mix of bonds and stocks minimizes the risk
• The phase of low interest rates makes bonds unattractive
• Investors with an affinity for risk can bet 100 percent on stocks
Shares, but also bonds, offer investors the opportunity to invest directly in a single company or issuer. However, there are very different opportunities and risks for the investor, which must be considered in advance of an investment.
The fundamental difference between bonds …
A bond, regardless of whether it is a corporate or government bond, is a bond with which the respective issuer collects debt capital from its investors. For this capital, the buyer or the creditor receives a fixed agreed interest, which is usually paid annually. In addition to this annual interest rate, the investor receives his full investment amount back at the end of the bond’s term, provided that the respective state or company is not insolvent.
With the help of a bond, an issuer procures outside capital, which, in contrast to the acquisition of shares, makes the investor only a creditor and not just a partial owner.
… and stocks
In contrast, the buyer of a share becomes a co-owner of the respective group. Accordingly, the shareholder owns a fraction of the entire company. In contrast to the placement of a bond, a corporation procures fresh equity and no debt capital by issuing shares.
While the return on a bond comes from the annual interest payments, the return on stocks is made up of dividends and price increases. Although bonds can also achieve price gains, the repayment of a bond always relates to the original nominal value.
In contrast to bonds, shares do not have a fixed term and can therefore remain in the portfolio for life.
The main similarities between bonds and stocks
Despite the fact that investors add debt to a company by buying a bond and equity by buying a share, both asset classes have a lot in common. Bonds and stocks can be traded on the stock exchange at any time, so their price is always determined by supply and demand. In addition, bonds and stocks can be kept together in a securities account. This means that both asset classes can also be acquired and traded together in a mixed fund or ETF.
Another thing that bonds and stocks have in common is the prospect of regular income. In this way, both asset classes can continuously generate profits, either in the form of dividends or in the form of interest payments.
Individual rights and risks with bonds …
With the purchase of a bond, the obligee acquires a right to regular interest payments and the repayment of his capital after the end of the respective term. If the company encounters payment difficulties during this period, the bondholder, unlike the shareholder, will also receive priority service.
This priority treatment is probably the greatest advantage of bonds over stocks. Apart from that, bonds naturally also involve special risks. The preferential treatment of the bondholder vis-à-vis the shareholder does not necessarily protect against a total loss. In addition to this issuer risk, bondholders also have to accept inflation, interest rate, exchange rate and currency risk.
… and stocks
In contrast to lenders, shareholders have a voting right due to their direct participation in the company, which can be exercised at an annual general meeting. In addition, in the event of a distribution, shareholders are entitled to part of the profit paid out. In addition, in the event of a capital increase, shareholders have a subscription right that enables them to purchase new shares with priority.
The classic risks that affect bondholders, of course, also apply to shareholders. Due to the higher susceptibility to fluctuations or higher volatility, as well as the subordinate treatment in the event of insolvency, shares nevertheless carry a much higher risk than bonds. Because while the bondholder can be relatively indifferent to the business development of the issuer, as long as the issuer is still solvent, the shareholder has a very great interest in the respective company developing well economically. Because only one
excellent business model paired with positive economic development offers the long-term opportunity for rising share prices.
The mix makes the difference
“The only thing you get for free when you invest is diversification,” Harry M. Markowitz’s most famous saying is. For the purpose of portfolio optimization, the US economist developed what is known as capital market theory in the 1950s, which deals with the interplay between return and risk.
With the help of this theory, Markowitz was able to show that the risk of an asset class can be minimized if the investor positions himself diversely. “What is free for Markowitz is not diversification per se, but the positive effect that investors buy with it. [
] With a broad diversification of their capital, investors can reduce their risk of loss on the one hand and increase their potential returns on the other, “says DWS fund manager Henning Potstada.
Investors should not only position themselves broadly within one asset class, but should also spread their wealth over various assets. “The most important thing when it comes to diversification, however, is the correct distribution of assets across different asset classes, such as stocks, bonds, currencies and commodities,” the DWS manager continued.
Accordingly, it can be worthwhile for investors to equip their securities account with both bonds and stocks. However, there is no general answer as to which exact division between these two asset classes makes sense. “A general rule of how an investor has a portfolio of stocks and shares [Anleihen] structure is there [..] Not. That depends on the individual – their investment goals, their investment horizon, their risk appetite and their age, “said Potstada in a DWS report.
The classic share-bond rule of thumb is obsolete
The classic share-bond rule of thumb “100 minus the age”, with which the supposedly optimal share quota can be calculated, is well known, but is no longer up-to-date. The formula says that a person who is 30 years old should invest 70 percent of their investment capital in stocks and 30 percent in bonds.
With a current life expectancy in Germany of 78.6 years for men and 83.4 years for women, however, a 30-year-old person still has at least 48 or 53 years ahead of them, which makes a 30 percent bond portion seem unnecessary. Because for the greater risk that an investor with shares takes on over time, he also receives a so-called share bonus, which brings with it a considerable difference in return. In addition, it is statistically verified that the world’s major stock indices, such as the S&P 500, have never made a loss within an investment period of around 10 years.
Yield spread between stocks and bonds
Investors who invested one US dollar in long-term US government bonds between 1925 and 2005 achieved a total of around 71 US dollars after 80 years, which corresponds to an annual nominal return of 5.5 percent. Investors who invested their US dollars in an S&P 500 ETF during this period, however, would have had assets of 2,658 US dollars with an annual nominal return of 10.4 percent. Of course, there were no ETFs in 1925, but the enormous difference in returns shows what long-term opportunities the stock market offers compared to the bond market.
Because of this, investors shouldn’t shy away from high equity exposure. In addition, the current low interest rate phase ensures that bonds with good credit ratings, even without taking the inflation rate into account, represent a predictable loss-making business for creditors.
In this context, André Kostolany put the eternal dilemma between security and return or stocks and bonds very aptly in one sentence. “Those who want to sleep well buy bonds, those who want to eat well buy stocks,” said the punter who died in 1999.
Pierre Bonnet / Forex-news.com.net
This text is for informational purposes only and does not represent an investment recommendation. Finanzen.net GmbH excludes any right of recourse.
Image Sources: Number1411 / Shutterstock.com, BlackAkaliko / Shutterstock.com