Quick buck vs stability
A senior business reporter at the South China Morning Post looks at how stocks and bonds can help balance your portfolio
Retail investors commonly invest in both stocks and bonds, but what's the difference? Why is everyone so excited about the stock market? Isn't the bond market going up as well?
Stocks and bonds are perhaps the two most common types of listed investments, but in many ways they are the exact opposite of each other. Both are issued by companies, and give investors a stake in the future success of the company, but their prices behave in very different ways.
In Hong Kong and the mainland retail investors have much more exposure to stocks because the bond markets remain underdeveloped. Selling bonds means a company is borrowing money from the public, and for many years, China's banks have been the main source of debt financing.
Mainland investors have for years put most of their money into the bank and left it there to collect interest. This means the banks have vaults full of money that they can lend out to companies that need to borrow money to grow, making bank financing relatively cheap and easy to obtain. In comparison, selling bonds was seen as a complicated process that opened the company up to increased scrutiny from outside investors.
Bonds are slow and steady
Bonds have also carried a rather dull image in comparison to the glamorous world of stock markets, where new listings are greeted with champagne and visits to the exchange by important officials. Bonds are not likely to rally sharply like stocks, filling investors' pockets with quick gains, but they're safer, more steady investments.
A bond includes two important numbers. The price at which it is bought and sold on the market, and the yield, or the interest rate that the company promises to pay in return for the money you lent to them by buying the bond.
When interest rates go up, bond prices go down and when interest rates go down, bond prices go up. For example, you might buy a five-year bond for HK$1,000, and it has a 5 per cent coupon, or interest rate. This means that you are lending the company HK$1,000 for five years, and they will pay you
5 per cent per year for using your money. You can sell this bond before the five years are over, but changes in interest rates may have changed the price at which you bought it.
If interest rates rise from
5 per cent to 6 per cent, the interest payments on the bond you own are now below the market level. Who will buy a bond that is paying 1 per cent below market rates? You will have to lower the price in order to make it more attractive, since you cannot change the interest rate on a bond once the company has issued it.
If interest rates went down instead of up, you could then sell your bond for more money than you paid for it because the coupon, or interest rate, would be higher than the current market rate.
Taking stock in a company
Stocks are generally more volatile than bonds, but over the long run stocks are expected to pay a bigger profit than bonds, rewarding the investor for taking this extra risk. That is why many investors add some bonds to their investment portfolio because they offer stability.
Just as price and yield are important to bonds, the price and dividend yield are important to stocks. The dividend is the share of profits the company will pay out every year to shareholders.
Owning a company's stock means you are investing in the future growth and profits of the company. However, the price of the shares can go up and down for reasons totally unrelated to the company. Political events, inflation and tax rates can all affect how investors view the future success of a company, and therefore affect share prices.
Buying stocks and bonds are the most common way to invest in corporations, and in order to have a balanced investment scheme, it's important to own a little bit of both.