How Are the Equity Market and Fixed-Income Market Different
So, you have decided to invest your money. A wise choice. Namely, investing is one of the best and most reliable (no matter how paradoxical this sounds) ways of creating a steady stream of passive income. Now, we advise that once you get some funds underway, and figure out what kind of investment strategy you want to try, you buy some securities. Things like stocks, bonds, options, all of these are investment assets that you can trade, and that make up a portfolio investors can build. Now, today we will be dealing with stock and with bonds since they are the two items that see the most trade done.
Stocks are also known as shares or as equity, that you can possess in a company, while bonds are fixed-income loans that you can make to a corporate entity or, perhaps, to the government. Below you can find our article where we compare and contrast the equity (stock) market and the fixed income (bond) market. You will also, first, find definitions of what bonds and stocks are, and what their important elements are. Without an understanding of what they actually these terms mean, you will find it rather difficult to get a good deal going.
A quick primer on bonds
So, let’s start with the bond market. Namely, a bond market is a place where investors go to trade debt securities. They buy and sell bonds, which are issued by companies or by the government. Now, the bond market is also called the debt or credit market, because all securities sold here are basically some kind of debt. When you buy credit security you are lending money and getting some interest form this lending. So, buying bonds means you are getting a steady source of passive income.
Before we continue, we should inform you of the people who actually take part in this market. First, you have the participants. They buy and sell bonds. When they do so, they are essentially issuing a loan and will receive some interest in return. After the bond reaches maturation, it will be paid back in accordance with its original value. The other important type of entity involved in the bond market is the underwriter. Underwriters evaluate risk. They buy securities, and they resell them. Finally, we have the actual issuers. These are the entities that create bonds. They register and sell them on the bond market. These are most of the time corporations, but, governments also sometimes issue bonds.
You should also be aware of bond ratings. Namely, bonds usually get investment grades. These show how great of a risk the bond has regarding defaulting. So, AAA and A ratings are high-quality bonds. A- or BBB bonds have a moderate level of risk. Finally, BB ratings, and lower, as seen as very high-risk bonds.
As far as how you can use these bonds, it’s totally centred on your own choices and wishes. For example, many people just hold their bonds in their portfolios, and use them to save up for retirement, or perhaps paying for their children’s education.
A big part of staying in touch with the bond market is doing just that – getting some research underway. There are many ways you can do this. For example, Morningstar, bond centres, the newspaper. Staying up to date with the bond market is vital if you don’t want to waste your money
As far as trading is concerned, there is no centralized location. Namely, most bonds are sold over the counter, and so you won’t really find specific investor s that directly participate in the bond market. What you do get, however, is interlocutors who do this for you. So, if you want to invest in a bond, you need to contact an asset manager, who directs bond funds. These can be pension fund foundations, investment banks, hedge funds, endowments…
So, you don’t really have access to a primary bond market (or rather, you do, you just won’t achieve much there). What actually happens is that bonds are just put up for sale on their primary market, further trading happens on the secondary one.
A primer on the Stocks
The stock markets are a place for making a fixed income investment. Investors come here to trade stocks, futures, and options. Unlike bonds, where you buy debt, buying stocks means you are buying a stake in certain companies. With bonds, you lend money and you gain money from interest. With stocks, you buy a small stake in certain companies, and you hope that said company will be successful, and that the value of the shares you bought will increase as well.
The actual point of the stock market is that it allows buyers and sellers to come together, and to have them trade in an environment that is controlled and regulated. This brings some order to the chaos that such high stakes trading can cause. Furthermore, a stock market basically guarantees that trading will be done honestly, with proper transparency. It’s supposed to help everybody involved, the traders, the corporations, the highest level Wall Street investor, and the average Joe who wants to earn some more money on the side.
There are several differences that differentiate the bond market from the stock market. Namely, the greatest might be the amount of risk that is involved when you deal with both. For example, when dealing with bonds, the main risk here is inflation and interest rates. It’s a fine balance of knowing when to sell and when to buy. For example, if interest rates are too high, the price of a bond will fall, and you might need to sell it before it matures leaving you with less money than you had before you bought them. Furthermore, companies that are not the strongest financially speaking, or that are just too risky, sell bonds that might create some credit risk on your part. Putting it simply, there is a high chance that this specific bond issue can’t pay its dues, it can’t make interest payments, which can lead the bond s to default, and the company open to bankruptcy. Stocks, on the other hand, carry their own risks. However, this risks centre more on geopolitics, liquidity, or interest rate risks.
Stocks are seen as equity instruments, while bonds are debt instruments. To continue on the topic of risk, you are not guaranteed any returns on your stocks, since these depend on how well the company does business. Furthermore, you also rely on the Board of Directors of said company, and their choices. Bonds, on the other hand, have their own fixed returns which must be paid out, no matter what their sum is or in what condition the borrower can be found (with few exceptions that are outside the scope of this article).
Furthermore, there is a difference between stockholders and bondholders. Namely, bondholders are essentially creditors to a company, they are lenders that expect to get their money back, but don’t really have any say in how the company is to be run. Stockholders, on the other hand, are basically owners of a company, to a greater or lesser degree. They, unlike bondholders, do in fact have a say in regard to important matters.
There are other issues that need to be addressed as well. For example, the returns for stocks are rarely proportional to the initial investment, both in terms of gaining or losing, money. So, without the right amount of research, you are pretty much gambling with stocks. Bonds on the other hand to have credit rating agencies which will help you in deciding how risky they are(not).
Investing in the stock market vs. the bond market
There are many recommendations regarding investing in these markets. However, ours will be focused on the risks we mentioned, as well as taking into account you’re going to play the long game. Namely, if you are interested in conserving your capital more than creating some insanely high returns, we suggest you go with 50% in stocks, and the rest in bonds. So, there will be some volatility and craziness with your stocks, but at the same time, you will get guaranteed returns from your bonds.
On the other hand, if you want high, 9% return on your profits, then your best bet is going completely into stocks. This, of course, brings with it its own dangers. Namely, stocks are the most volatile investment strategy, and going 100% can mean that you will end up with less money than what you started with. Of course, everything between 50% and 100% in stocks means variety in risk.
Understand that making a good investment is centred almost completely on doing your homework. The main point here is that you need to figure out how much you want to invest, and how much risk are you willing to bear. Furthermore, investments of these types are always for the long term.
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