Equity Vs. Fixed IncomeDifferences You Need to Know Between the Two!
Equity and fixed income are both classifications of financial instruments that can be bought and traded by investors.
Equity typically refers to shares of stock, whereas fixed income typically consists of both corporate and government bonds.
These two types of investments differ considerably in their levels of risk and potential returns.
Equity markets possess a high degree of volatility, and investors face greater risk and a correspondingly higher potential for return.
Fixed income markets are more stable and, as a result, offer lower risk and lower potential returns.
Generally, individual investors have a greater degree of access to equity markets; however, investors will often attempt to build a diverse mix of both types of assets when building their portfolios.
What Is Equity?
Equity investments refer to the purchase of stocks that are partial ownership or share of a company.
Equity is one of the principal classifications of assets and plays a major role in investing.
Because equity, unlike fixed-income securities, offers partial ownership of a company and its assets, investors will choose to invest in a company based on the belief that its value will rise.
Stocks offer dividends which are discretionary payments the issuing company may pay stockholders often on a quarterly basis.
There are two categories of stock, including common stock and preferred stocks.
Common stocks are the most commonly traded and give holders the right to a portion of a company’s assets, distributions of dividends, and the right to vote at shareholder meetings.
Preferred stocks offer the right to assets, as well as entitlement to receive dividends before they are paid to common stockholders, but offer no right to vote at shareholder meetings.
The prices of equities can vary considerably no matter the market, and the high risks and high potential rewards have led to many complex strategies for investing.
This includes methods to mitigate risk, such as index funds which are a type of mutual fund that are designed to provide broad market exposure and mimic the risks and returns of an entire equity market.
What Is Fixed Income?
Fixed income securities are composed of bond securities which include bonds issued by the federal government, corporations, municipalities, and mortgage debt instruments.
These investments offer fixed returns at specified intervals and are often referred to as debt securities or bonds.
There are two principal kinds of bonds which are zero-coupon bonds and coupon bonds.
A zero-coupon bond provides only a single payment which is the par-value (face value) of the bond when it reaches maturity.
Because there are no other payments made before maturity, these are sold at a discount to their par value which is equivalent to the return these bonds offer investors.
Coupon bonds offer regular cash flow to investors through coupon (interest) payments made at specified intervals until the bond reaches maturity.
The coupon payments will typically be made semi-annually for U.S. bonds.
The holding period for bonds can vary considerably from only a few months to multiple decades.
Fixed income investments are generally perceived as relatively low-risk investments compared to equities and, as a result, generally offer significantly lower potential returns.
Fixed income investments are typically less accessible for individual investors, who often participate in this market through mutual funds.
Equity Vs. Fixed Income Head to Head
|Ownership||Equity investments offer partial ownership in a company.||Fixed income investments offer only a claim to the promised payments.|
|Issuers||Equity investments are primarily offered by corporations.||Fixed income investments are offered by private companies, municipal governments, and the federal government.|
|Level of Risk||Equity investments possess a high level of risk.||Fixed income investments are generally low risk.|
|Returns||Equity returns are generally high in order to compensate for the high risk.||Fixed income returns are generally low due to the high likelihood they will be paid.|
|Control||Equity holders are partial owners of a company and generally have voting rights.||Bondholders are creditors not owners and have no voting rights.|
There are several key distinctions between these types of investments.
Here are some of the most significant.
Equity investments give investors partial ownership of a company, including the right to vote in shareholder meetings and receive dividends at the discretion of management. In contrast, bondholders are simply creditors that have a claim to receive the principal that they have loaned the issuer plus interest.
In some cases, this may be backed by a claim to specified assets if the issuer fails to repay the investor, but this is not true in all cases.
Level of Risk and Returns
The potential returns offered by equity investments far surpass those of fixed-income investments.
However, in order to gain these higher returns, investors must accept a far higher risk of losing money off of their investment.
Equity markets are inherently unstable, and stock prices fluctuate wildly.
This may occur due to systematic risks, which are the risks inherent to an entire market or market segment and are associated with downturns that affect entire equity markets, not just a particular stock or industry.
Alternatively, risks may be unsystematic, which means the risk associated with particular stocks or industries can be mitigated through diversifying investments.
In contrast, fixed income markets are relatively stable, and the only risk is generally that the issuer will default on their payments.
Though this is possible, the risk of loss is generally far lower than in equity markets, and as a result, the potential returns from these investments are far lower.
These investments offer a relatively high guarantee of receiving the specified returns; however, in some cases, the low returns offered by fixed-income investments may prove to be lower than inflation.
As a result, investors could potentially run the risk of losing the value of their investment.
Result of Bankruptcy
When a business goes bankrupt, bondholders have a higher claim on assets than equity holders.
If a business were to issue both equity and bonds and then were to go bankrupt, bondholders would have a first claim on the sale of remaining assets.
This means that all bondholders will be repaid, and equity holders will only have a claim to what is left after this, if there is anything remaining at all.
Both equity and fixed income instruments are significant components of a well-balanced investment portfolio.
Equity possesses high risk and high reward, which can help to accrue value and outpace inflation.
Whereas fixed income investments are a crucial tool for guaranteeing returns and providing stability to an investment portfolio.
The precise balance between these investments depends upon an investor’s tolerance to risk and long-term goals.
- Equity and fixed-income markets trade in different types of securities and possess different levels of risk to reward.
- Equity instruments possess a relatively high level of volatility, and as a result, both the risk and potential rewards are higher than for fixed income instruments.
- Fixed income instruments possess a relatively low level of risk and correspondingly lower potential rewards when compared with equity instruments.
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