Are Stocks Riskier than Bonds?

Bonds are different from stocks in that bonds are structured more like a loan to a business. Because of that, with a typical bond issue, you know exactly how much money you will receive and when it will come (of course that assumes the company will not go bankrupt). With a typical bond, you might receive something like a 6% yield, probably paying 3% every six months. When you hold it to maturity, you will receive the face value of the bond back, something like $10000. Of course you may have to hold it 20 or 30 years to get that.

There is the problem. You may not be able to hold the bond to its final maturity. When that happens, you can sell thge bond on the open market. However, if interest rates have gone up since you purchased the bond, you will receive less than face value of the bond in return. Conversely, if interest rates go down, you might actually receive more than face value for your bond.

One other risk with bonds comes if you have purchased a "callable" bond. With a callable bond, the issuing company retains the right to redeem, or call, the bond before maturity. Basically they retain the right to buy it back even if the price has gone up. They may want to do this if interest rates were to fall, so they could reissue the bond and pay the lower interest rate. This happens because the interest that is actually paid every quarter or 6 months is less than the market rate. If the bond price falls, then the effective interest rate goes up. (Example: a 30 year bond with a face value of 1000 and a 6% interest rate will pay $60 a year. If interest rates were to go to 8%, then the bond price will fall to a range around $775. The combination of the fact that you invest less but get the same interest payment, along with the fact that the face value paid at maturity is represents a gain over the amount paid give a net yield of 8% for this case.) You can calculate this easily on most spreadsheets.

So stocks are riskier than bonds because bonds will have a fairly well know cash flow. A stock, of course, does not, but that is why the both the upside and downside potential for a stock is some much greater. If the earnings for the company increase quickly, the bond holders only benefit by the fact that the market interest rate the company has to pay might go down. If you never sell the bond before maturity that increase doesn't benefit you at all You will never score big holding a bond to maturity, while with a stock there is a lot more potential to win big. And the stock can theoretically continue to pay dividends or generate earning beyond the time horizon of the bonds the company issues.

Finally, the average investor won't hold individual bonds in their investment accounts. The average investor is more likely to hold mutual funds, specifically bond mutual funds. This is almost always the case in retirement portfolios like IRAs and 401ks. And the fact is that bond funds behave differently than individual bonds issues. This difference is enough that the conventional wisdom that stocks are riskier than bonds may not be true...

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We have more information about stocks versus bonds at www.fundztrader.com You can find articles about finding the best mutual funds and other topics on mutual funds as well.

Tags: BONDS, STOCKS, MUTUAL FUNDS

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Title:	Are Stocks Riskier than Bonds?
Author:	John Ruppel
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Are Stocks Riskier than Bonds?