When people in finance talk money, they use a lot of terms that don’t always make sense to the rest of us. Here we break down what the difference is between equities and fixed income …
Equities vs Fixed Income: What’s the difference?
When people invest in stocks and shares, such as simulated in our fantasy trading competition, this is called an equity investment. It is so called because when you buy a share, you are in effect, a part owner of the company. Stocks, shares, equity, and shares of stock are terms that tend to be used interchangeably. Companies will often give up equity (partial ownership of the business) in exchange for cash. When you hear of a company “going public” – they are undertaking an initial public offering (IPO) by selling shares (part ownership) to the public and thus raising additional capital.
Another way for companies to raise capital is to issue bonds. Bonds work like a loan to the company, the company pays an interest rate to the bond holders on a fixed schedule until the bond matures. It is because of this fixed interest rate that they earn the name: fixed income. At maturity the company pays off the borrowed amount. The most common types of bonds are those issued by governments and corporations.
Risk and rewards
As the financial instrument works, when you own a stock or share in a company, you own a part of that company, whether it be big or small. Even if it’s 0.02% of a share, you’re still a shareholder. Therefore, the rewards you may reap are tied to the fortunes of the company. If a company stock jumps 30%, you can look forward to an excellent gain on your investment, and vice versa, if the stock takes a big hit, your investment will also plummet. Our investment experts will always tell you to diversify, having all your eggs in one basket is extremely risky.
Bonds work differently when it comes to company success. A corporation could have an excellent financial quarter, but bondholders will only receive the agreed interest payment and eventually (usually after 5 years or so) the entire amount of the bond. The returns can be small but reliable and consistent and the risk to the investor is much lower than that of the variable returns of stocks. One risk to fixed income returns is that the interest payment is fixed regardless of inflation, therefore if inflation goes up by 3% and the return is set at 5%, a bondholder’s income is being eaten away.
Most bonds are guaranteed by governments or 100% guaranteed by corporations, meaning the investor will get all their initial investment back.
Advantages of Fixed Income
For investors looking for a low-risk, less volatile reward, fixed income is a great option. It allows investors to plan as it provides a steady income, making them extremely popular products for those in retirement. Additionally, most bonds are guaranteed by governments or 100% guaranteed by corporations, meaning the investor will get all their initial investment back. They are an easier investment to keep an eye on compared to the active trading and research that buying stocks requires.
Things to consider when choosing an investment bond
Fixed income bonds can be tailored towards the needs of an investor. There are many different types of bonds on the market, so the most important thing an investor can do is read the fine print. Important details such as when the bond is due to mature cannot be missed. The investor must also consider their risk level and if they can really afford to lock their money away for 5 years or more. Are there life events on the horizon that the investment money should be saved for? Ideally, a portfolio should contain some allocation to fixed income that becomes increasingly larger as an investor approaches retirement age.