Equity and fixed income investments each reflect very different risk and return profiles. Investors who buy equities are taking on more risk because the stock market, which is where equities are traded, can be extremely volatile. Bonds, which are fixed income securities, provide steady but moderate returns. Investors can essentially buy and sell stocks at will, but bond contracts exist for a predetermined length of time. Investors often balance a portfolio between stocks and bonds based on the amount of risk that they desire to take.
Stocks grant investors an equity stake in a corporation. In exchange for buying stocks, investors become eligible for perks such as quarterly dividend distributions, which are payments made from a company's excess profits. Equity investors also obtain the right to vote on major corporate happenings, such as a merger with another company or a change in corporate governance. The market value of a stock often rises and falls in conjunction with earnings, which reflect profits and loss at a corporation, according to Russell Investments.
Fixed income investments represent loans that investors extend to corporations or government bodies. Bond issuers make interest payments to investors based on the face value of the security. Unless a bond issuer defaults, investors also receive the face value of a bond security when the contract ends. The life of a bond can range anywhere from three months to 30 years and may be issued by a corporation, government or municipality. Investment grade bonds are among the safest fixed income securities, while bonds rated below investment grade pay higher interest but have a greater chance for default.
When a company falls into bankruptcy, it may mean that both equity and fixed income investments are lost. In the event that a corporation is able to generate some liquidity, or money, bond investors have priority over equity investors for repayment. While it is unusual for government or municipal bond issuers to default, it can happen. In 2012 after the city of Stockton, California, filed for bankruptcy protection, the city was threatening to abandon its bond investors and leave them with losses, according to an article in Barron's.
Historically, equities and fixed income investments respond differently to financial conditions. As a result, these two investment categories are considered non-correlated to one another. After the financial crisis the led to the Great Recession began to unfold in late 2007, however, stocks and bonds were both losing value amid gloomy economic conditions. It wasn't until 2010 that equities started to trade based on corporate profits and bond prices became sensitive to monetary policy once again, according to an article in Bloomberg.
Video of the Day
- retirement at last image by Pix by Marti from Fotolia.com