Investment decisions are very difficult to make especially if you are not a financial analyst and it sometimes become even scary when you have no financial literacy background. The reason is simple; you are making a decision that might make or unmake you, or turn your whole life worth of savings into some few pennies. Even though financial analyst and investment brokers are there to advice you on what investment vehicle suites your need, it is usually better and much safer if you understand the basis of what these ‘experts’ are offering you. In this article, I will be comparing two major investment vehicles which are increasingly popular in the ‘investosphere’ – shares and bonds.
Shares literally mean parts of the whole and that is exactly it’s meaning in investment. It refers to part ownership in the entity whose share your are buying. Therefore, after buying the shares you legitimately become part owner of the company. The extent of your ownership depends how big your piece of the cake is. Owning a few hundreds, or thousands or even hundreds of thousands of the shares simply give you certain basic rights such as voting at annual general meetings or passing of certain emergency general meetings.
This form of ownership is referred to as non-controlling interest – because you have limited control in the business. However, if you own a very significant number of shares, usually 50% plus 1 shares, you are able to make any decision at all including but not limited to changing the company’s name, removing the directors, deciding on acquisitions and disposals, changing the company’s name and even changing corporate colors and location of headquarters if you so wish, except when a special resolution has being passed to limit the decisions that you may take and you voted in favor of that decision. This form of ownership is called Controlling interesting – because you have greater control in the running of the company.
Shares generally come into two forms namely ordinary shares and preference shares. Ordinary shares do not receive variation in income and such incomes are tied to the performance of the company. Preference shares however receive fixed income and such income may or may not be tied to the performance to the company. This makes preference shares less risky than ordinary shares. It is worthy to note that there are a lot of difference between ordinary shares and preference shares but for the sake of this article, I have only cited the most prominent and relevant one above.
Revenue from shares basically comes in two forms; dividends and capital gains. Dividends are the annual returns that the company pays on each share based on the performance of the company and it is entirely a decision made by the directors. They vary from year to year to year and as they are based on the performance of the company, previous years’ dividends practically are no indicator of future dividends. One thing worthy to note is that the fact that it is based on performance does not mean a company that pays dividend is doing well neither is a company not paying dividend automatically doing bad. Ideally, the only time a company should pay dividend on shares is when the directors are unable to identify any projects that yields returns more than what the individual would earn investing his dividend.
The other part of revenue from shares is the capital gain. Capital gain is the appreciation in the value of shares over a period. So if you bought 1,000 shares for $1000 a year ago and today you could sell the same 1,000 share for $1,300, the $300 difference is the capital gain. Capital gain rises as the company’s performance increases, the company invests in positive returns project and also when investors’ perception of the value of the company grows in a positive light.
Bond is a financial security that indicates a contract to repay an amount borrowed together with accrued interest at a future time. The bond is issued by the issuer and the company to whom the bond is issued is called the bondholder. Unlike that of shares, the bondholder does not become part owner of the company however he is a creditor to the company. Depending on the terms of the contracts and the type of bond however, the company may have to consult the bondholder before certain decisions are taken by the company. A bond may be a secured one, where the bondholder has a lien over some properties of the company in the event of liquidation. The company may also have to consult the bondholder before significant actions are taken on the properties such as using them as collateral, disposing them off or replacing them. An unsecured bond however, which may also be referred to as a floating bond, do not give the bond holder right over any specific property of the company. In the event of the liquidation therefore, the holder of the secured bond has priority over that of unsecured bondholder. Because of the riskiness of unsecured bond, holders are usually compensated with higher interest than that of the secured bond.
Revenue from bond is basically the interest payment which is usually paid half-year or yearly. The payment is referred to as coupon payment. Normally bonds may be convertible or non-convertible. Convertible bonds are those that can be substituted for shares in the company as per the contract whiles non-convertible do not have those option.
Before you decide to invest whether in shares or bonds, you must therefore note the following.
Ø Shares make you a part owner, bonds do not. It only makes you a creditor.
Ø Shares (ordinary shares) fluctuate in earnings, bonds have fixed earnings.
Ø Shares are basically tied to the performance of the company, bonds are not.
Ø Shares are easily tradable; bonds however require a highly developed bond market.
Ø Shares are generally riskier than bonds. Bonds are therefore usually safer than shares.