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About Me

Darren Winters is a self made investment multi-millionaire and successful entrepreneur. Amongst
his many businesses he owns the number 1 investment training company in the UK and Europe.
This company provides training courses in stock market, forex and property investing and since
the year 2000 has successfully trained over 250,000 people.

Monday, 12 May 2014

Bonds Versus Shares .... Which Is The Right Option For The Investor?

Should you be investing in bonds or shares? That’s a tough question to mull over.  Let’s take a look at both financial instruments.
Bonds are supposedly less risky to invest compared to shares. This is so because in the unfortunate event of business insolvency/bankruptcy, the bond holder (investor in bonds) comes ahead of the equity shareholders in terms of payouts should the entity be made insolvent. On the other hand, the equity investor is last in line to be paid and more often than not business failure to an equity investor equates to an almost certain loss of their entire capital that he/she has invested in the failed business. With respect to bonds, the bond holder is promised by the party receiving the money (the Issuer), to repay the face value of the bond (the principal) at a specified date (maturity date.) In view of this, it becomes apparent that capital is more exposed to risks when it is invested in shares rather than bonds.  

In terms of providing an income there is also a distinction between shares and bonds. In the latter, the investor in bonds is often provided with fixed yields, the main advantage here being that he/she is able to predict income from their investments. This is an attractive feature for investors approaching retirement, when regular income from their investment is more favorable investment strategy than exposing their capital to higher risks.                                     
For example, if an investor where to buy a bond with say 10% coupon at its 1,000 USD par value, the yield is 10% (100 USD/ 1,000 USD).  That seems straightforward. But the investor in bonds needs to bear in mind that the price of bonds fluctuates on the bond market. So assuming the bond price goes down to 800 USD, then the yield goes up to 12.5%. This occurs because the investor receives the same guaranteed 100 USD on an asset worth 800 USD (100 USD/800 USD).
Conversely, if the bond goes up in price to USD 1,200, the yield shrinks to 8.33% (100 USD/1,200 USD).

Shares do offer income to the investor in terms of dividend payments, but income from this is not predetermined and can be unreliable.  Note that dividend payments on shares usually depends on the performance of the company throughout its financial year and the amount of income paid, if any, is recommended by the company’s board directors. So the investor has no real way of deriving a stable income from shares. In some years the shares may pay dividends, whilst in other years, little or no dividends may be paid out. 

Despite the uncertainty of income that shares offer investors their main attraction as an asset class is their potential to offer the investor capital growth. However, the general rule of thumb for investing is applicable in share investing, that being the higher the potential risk to the capital the higher the rewards received by the investor and visa versa.
In other words, there is a positive relationship between rewards and risks. 
If the investor is willing to forsake higher risk for the potential of greater returns, then equities may be the suitable financial instrument for him to achieve his goal. This is one of the main advantages of share investments compared to bonds-the potential of capital growth.  A young investor, a long way from retirement may prefer an investment strategy where their investments are more geared towards growth, rather than immediate income. This means that their investment portfolio may be orientated more towards shares rather than bonds.  So the investment goal of the investor could determine whether investing in bonds is more suitable than shares. 

Indeed, volatility is another distinction between the two financial instruments. Share can fluctuate widely on the future potential profitability of the business, on the expected earnings.  Technology stocks, pharmaceutical stocks investigating in new drugs for say cancer, or prospecting oil/ mining stocks share prices have the potential of gyrating widely on the stock market based on the prospects of positive events influencing the company’s profitability.  Investing in these types of companies before the positive event has been factored into the share price offers investor the potential of large capital gains. A photo looking like a bunch of long haired hippies, featuring micro soft founders in 1978, states, “would have you invested.”
If an investor were fortunate enough to have bought 100 shares at 21 USD in MicroSoft in 1986, an investment 2,100 USD, those shares over the course of nine stock piles would have mushroomed to 28,800 shares. Assuming the investor then sold those shares in December 1, 1999 he would have bagged a massive 1.4 million USD.  Sure, this is easier said than done, but no doubt this will probably wets the appetite for shares, even amongst the diehard cynics among you.    

Another bonus of share investing is that the investor owns a piece of the company. There are different classes of shares with different voting rights. Shareholders are invited to attend annual meeting of the company, they can vote on issues that influence the business, such as takeover and acquisitions of the business, changes to members of the board. Naturally, the larger the shareholdings in a company the more voting clout the shareholder investor has in selecting senior executives who will run the company and voting on import issues that could influence the business.   In contrast, a bond holder doesn’t acquire ownership in the business; they have no voting rights and no way of influencing the business.

So the theory goes that bonds are a supposedly the safer bet than shares-they are the more preferred asset by the grey haired people among us.  But so is gold considered the ultimate safe haven, the ultimate rat hole to climb into when things go pair shaped. Despite this common held view gold investors eroded 28 percent of their capital in 2013, it was the worse year for gold since 1981. Bond investors also experienced the worse year in living memory in 2013.  Indeed, playing safe last year has left some investors feeling very sorry for themselves, but will the appetite for risk continue into 2014…? 


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