Stocks and Bonds, what's the Difference?

Stocks and Bonds, what's the Difference?

Why is it necessary to explain the difference between stocks and bonds? Because knowing the difference between stocks and bonds will add options to your investment.

So first I want to explain the difference between stocks and bonds. I will quote the notion of shares from the idx website, so shares can be defined as a sign of a person's or party's capital participation in a company or limited liability company. From this definition it is written that the company issues shares to obtain business capital from a certain person or party. So the emphasis is on issuing shares to raise capital.

In contrast to bonds, where bonds are transferable medium to long-term debt securities and contain a promise from the issuing party to pay compensation in the form of interest for a certain period and pay off the principal at a time determined by the buyer.

So if we look at the definition of bonds, the government or companies issue bonds to get loans. So if we take the example of a company, if the company gets capital from selling shares it will enter into Equity. Meanwhile, if the company gets a loan from bonds, it will enter into liabilities or debt.

So that's a glimpse of the differences between the two types of stock and bond investments. Now I will explain the advantages and disadvantages of these two investment instruments. So in investing there are 2 important factors that underlie decision making, namely profits or commonly called capital gains and risks borne.

First I will discuss in terms of the ability to make money. If we look at these 2 types of investments, the possibility to make more money is stocks because stock investments can experience unlimited movements. As for bonds, you will only get money from coupon payments or yields where the payment is fixed and you can also get money from the difference between the purchase price of your bonds and the selling price of your bonds.

But if we look at the risk that is borne, the stock has a greater risk and the possibility of a greater return, then there is also a very large loss. And the heaviest risk of investing in stocks is that the company you buy can be delisted from the stock exchange or in other words that the company you buy goes bankrupt.

According to the rules, a bankrupt company must pay off its debts first and then after the remaining money will be distributed to all shareholders as compensation. But it is different from bonds where your bonds are guaranteed by the government, because according to Law NO. 24 of 2002 concerning government bonds.

There it is written that the government is obliged to pay the interest and principal debt of each state debt at maturity. So from the law it can be said that if you invest in government bonds then the possibility of your investment not being paid off is small unless our country goes bankrupt.

So the conclusion is that if you invest in stocks then you have the possibility to make very large money or capital gains but it is also accompanied by the possibility of large losses too or worse until it is not worth it. Meanwhile, if you invest in bonds, you will benefit from the coupon and you will benefit from the difference between the selling price and the purchase price of your bonds.

Meanwhile, the risk that you bear is almost non-existent unless the country or company you are buying bonds with goes bankrupt.

Now I will explain the relationship between stocks and bonds as you can see from the following chart;

You can see that sometimes stock price movements go hand in hand with bond yields and sometimes the opposite. Why are these two instruments related? Because these two instruments are like people fighting over each other for capital. These two instruments promote each other with their respective advantages and risks.

When stock prices from bond yields run in the same direction, it happens when the economy has just come out of recession or in other words is undergoing a recovery process from recession and inflation is still low. At that time the benchmark interest rate was still low and stock prices were still falling.

Therefore, at this time the two investment instruments moved together because investors were still buying bonds because the benchmark interest rate was still low and started to also invest in stock instruments because the stock price was still cheap. When the economy continues to improve, companies will start to improve.

This makes stock investment attractive because stock prices increase but this is inversely proportional to bond prices. Because when stock investment improves, investors tend to switch to stock investment because it promises bigger profits and less risk borne by investors due to improving economic conditions. This makes investors abandon bonds.

When the economy reaches its peak and will experience a recession, at this time interest rates are high and company expansion begins to slow down this causes stagnation in stock prices, or worse, stock prices become even worse or bearish.

But this actually makes investors turn to bond investments because they promise higher yields but are safe.