Investing in a Business vs. Investing in Stock or Bonds
When you choose an investment, you must weigh your likelihood of success. You can put money into a business hoping it pays you a return, or you can opt for investments like stocks. However, even buying stocks or corporate bonds is an investment in a business; with stocks you buy shares of a company, and with corporate bonds you are lending money to the company in exchange for interest payments.
You not only should expect a profit on your investment, you should expect to get your original investment amount back. Investing directly in a business carries a lot of risk. According to the U.S. Census Bureau, 10 to 13 percent of all businesses failed from 1977 to 2005. About half of all new businesses fail in the first five years. If you buy stocks or bonds of a company that has passed the five-year mark, you stand a better chance that the business will continue earning income. Stocks tend to fluctuate in value more than bonds, so your general hierarchy of safety from least safe to most safe is: investing directly in a business; investing in stocks; and investing in bonds. These levels of safety are general; you need to evaluate each company individually.
Income and Growth
When you invest directly in a business, you can either ask for regular payments or receive a percentage of the profits. As long as the company prospers, you receive income from your investment. You have the greatest opportunity for growth by sharing in the profits. If the company is extremely successful, you may make a fortune off your original investment. Stocks also can grow in value, and some provide income in the form of dividends. This income and growth tends to be higher with smaller companies that haven't fully established themselves, but such companies are more prone to failure than large companies. Bonds are designed for income. You can buy bonds that pay a set percentage rate for the life of the investment. Some bonds grow in value, meaning you can sell them for a profit.
Expected Rate of Return
The higher the return you want, the more risk you must take. This is the closest thing to a hard-and-fast rule in investing. Chances are that if you expect an investment in a business to double or quadruple your money, you are looking at a high-risk investment. Your investment in stocks could yield an upside surprise by doubling your money, but the average return on the stock market has been 7.2 percent for any 20-year period between 1950 and 2010. Bonds pay a set interest rate at the time you make your investment.
Making money is one thing. Getting your hands on it is another. The ease of converting your investment back into cash is known as liquidity. Stocks can be very liquid if they are listed on the NASDAQ, the DOW or the S&P 500 because these exchanges attract millions of investors daily. Often, you can sell stocks on these exchanges in a day and have your funds in three days, the amount of time regulators allow for a stock transaction to "settle," meaning for the buyer's cash to arrive in your brokerage account. Bonds can take longer. Even if you offer your bonds for sale through a discount brokerage, you might have to wait several days while people look at competing bonds. Buyers of bonds can purchase them the same day you offer them, but if other bonds pay higher interest, you might have to offer a discount to attract buyers. To get your money out of a business you have invested in directly could require the owner to sell the business or raise cash to pay you off. This makes investing in a business the least liquid of your options.
Kevin Johnston writes for Ameriprise Financial, the Rutgers University MBA Program and Evan Carmichael. He has written about business, marketing, finance, sales and investing for publications such as "The New York Daily News," "Business Age" and "Nation's Business." He is an instructional designer with credits for companies such as ADP, Standard and Poor's and Bank of America.