What distinguishes stocks from bonds?

Stocks represent ownership in a corporation; bonds are loans. This distinction is fundamental to understanding the nature of these two types of investment vehicles. When an individual purchases stock, they are buying a share of ownership in a company. This ownership typically comes with a claim on part of the company’s assets and earnings, as well as voting rights in company decisions.

On the other hand, when someone purchases a bond, they are essentially lending money to the issuer of the bond (which could be a corporation, municipality, or government) for a defined period at a specified interest rate. The bondholder does not own a piece of the company or entity but instead has a creditor’s claim to be repaid the principal amount along with interest.

Understanding this difference is crucial for investors when making decisions about their portfolios. It impacts their risk tolerance, investment strategy, and expectations regarding returns. Stocks often have the potential for higher returns through capital appreciation and dividends, but they also carry a higher risk due to market volatility. In contrast, bonds are generally considered safer investments that provide fixed interest returns, albeit with lower potential for growth compared to stocks.