Many investors, including the new and even the experienced ones, usually believe in this old saying, “Investing in bonds is safer than stocks.” However, that is not true. Even Benjamin Graham mentions that there are times when someone gets difficulties in deciding between bond or stock investment. They have to ask themself about the terms and the price.
Why Stock Investment can be Better?
These following examples may help you to understand better. If you have two choices of investment, one is to invest in a bond with an annual 8.5% interest.
If the company faces bankruptcy in the future you will be the third in line to get your capital back. That is after other creditors for anything that remains after the asset has been liquified. (This is named a liquidation preference. It can vary for every company. Some companies put bondholders first, then preferred stockholders, and common stockholders.)
Your second choice is to invest in the common stock of a debt-free company. this company trades at a 10 p/e ratio, which is a 10% earnings yield.
Around 5% out of the company profits are sent to the shareholders each year as the dividend. That makes a 5% dividend yield. The company management, sales, and growing are all good. If anything goes wrong, the stockholders will be the priority in the liquidation preference since there is no bondholders and preferred stockholders.
Within this scenario, then the best choice you have is to invest in a stock.
The Reasons of Why People Believe in the Old Saying
Even if in all cases the old saying is clearly false, but there are many people who keep believing in it. The main reason for that is many investors, especially the new and inexperienced ones, mistake volatility with risk.
Volatility represents the quick and frequent changes in an asset price. The changes usually are significantly higher or lower.
Yet, the truth is, volatility and risk are not always be the same thing. It may be hard to be understood, but there are investors who will be happy to get 5.2% interest, after expecting 8.5% in a world with 11% inflation.
These investors keep their pace with the inflation to gain a long term net worth and purchasing power, while suffering from the drops and raises of the stock price fluctuates.
