Historically, stocks have always had greater return potential compared to bonds. However, the huge risk that could result if a company’s performance plummets might not be worth the shot for some investors. That’s unlike bonds, where the principal lent is partially or fully recovered if any mishap ensues.
Overview of Stocks
Stocks imply ownership by part in a company. It can also be in the form of equity shares, corporate stock, common stock, or equity securities. When you buy a stock, you purchase a percentage of the establishment. The number of shares you decide to get equals the extent of the company you own.
Being a shareholder in a company also makes you a partner. So, if the firm performs consistently well after you’ve purchased its stocks, the value rises. This also means you’re a beneficiary of this progress, and you reap that in profit.
Let’s say the company sold at a stock price of $20 per share. Then you invest $1,000. A rise to $40 means a 100% increase, which will cause the value of your investment to double (per the 100%) to $2,000. This makes your profit $1,000, and you can again resell.
But while it’s good to look at the pleasant outcome, the bad side is also very likely. Suppose the company underperforms; you can lose a considerable share. And occasionally, the entirety of your investment.
Overview of Bonds
Contrary to what you might know. It’s not only financial institutes that can offer loans to big corporations. A bond purchase is a way wealthy individuals loan funds to companies or even the government.
When you buy a bond, the organization or governmental body owes you. And you get paid interest on the loan for a stipulated period. After which, it’ll return the total amount the bond was worth.
However, this doesn’t mean bonds are devoid of risk. If the company runs down, your payment is halted. And sometimes, you might not get paid your principal in full.
The Answer to the Big Question
A straightforward answer to why stocks outperform bonds is “the degree of risk to return.” In other words, greater risk equals more return.
As discussed earlier, bonds are loans that guarantee a fixed return. Moreover, institutions also commit to paying the principal after a while. On the other hand, stockholders are partial owners of a company. And they’re entitled to the share of earnings accrued over time.
Companies put out their stocks for sale for several reasons— most of which are driven by their financial planning. Even after they’ve made profits over the years, some decide to pay a quota of shareholders’ dividends and retain the left. The kept earnings are again used to foster their operations and increase their growth.
The greater risks accompanying the downfall of a company allow stocks to be of higher returns. If the company fails or goes bankrupt, all shares will be lost. But when things go well, the price often tips upward to favor the investor. Hence prospects decide the price to pay for a stock based on calculated risk and the expected possible return.
