The world of investing can often seem confusing. Venture capital, Series B, private equity, hedging – the list of complex financial terminology is endless. However, there are ways to make it simpler.
Two of the most cited terms in finance are stocks, also known as equities, and debt, usually referred to as bonds or fixed-income securities. But what are they, and what are the big differences between the two?
When it comes to the stock market, this is the place where company shares are bought and sold; think Apple, Lyft, Amazon and Facebook. The stock market includes smaller companies as well. You can even buy stock in a start-up company without it being listed on a major exchange.
In fact, investing in start-ups became easier in 2012 with the passage of the JOBS Act, which relaxed some federal securities regulations, making it easier for businesses to seek investments through crowdfunding.
The net result is the emergence of platforms like Fundit, which gives investors the opportunity to inject capital into new businesses and potentially make some money.
The debt market is where investment in loans are bought and sold; they are essentially an “I owe you.” Bonds are the most common form of debt investment and are issued by corporations or by governments to raise capital for their operations. They generally carry fixed interest rates.
There are important, subtle differences to note when investing in stocks or debt. In general, stocks are considered a riskier investment, but that comes with a caveat. Stocks usually have the potential to deliver a higher return than other investments – including debt.
There are many ways you can profit from buying shares in a business. For example, some companies pay a dividend as a reward for holding shares. Dividends are the percentage of company profits returned to shareholders.
A person who holds shares may also profit from the sale of the stock if the market price increases. Both investors in public companies and private start-ups can make money this way. Equity in a start-up is less liquid than holding shares in a public company.
It is important to note, however, that equity investment success depends almost entirely upon a company’s rising stock price, which is fundamentally linked to the performance, growth and profitability of the company. There’s no guarantee of any company’s success, and investors in stocks can lose money. If a company goes bankrupt, common stockholders are the last in line to share in the proceeds.
Typically speaking, investments in debt involve less risk than stocks because they are less volatile. Because of this, they may offer a lower return on investment.
Yet bonds to carry risk. A bond is a form of debt in which the investor is the lender; an institution, in return for financing, pays a premium to its lenders. Additionally, an investor receives the bond's face value at maturity. However, payback and all premium payments depend entirely on the borrower’s ability to generate enough cash flow to repay bondholders. Bonds are also subject to interest rate risk: when market interest rates rise, prices of fixed-rate bonds fall.
What type of investment is right for you very much depends on your investment goals. If you’re someone with higher risk tolerance, buying shares in a start-up or early-stage company could be the right option. While at the other end, if you’re more risk-averse and want a safer place to put your money, buying shares in a public company or purchasing bonds could be your best bet.
Finally, investment in stocks and bonds are not a zero-sum game. Investors often prefer to have diversified portfolios – giving them the best of both worlds.
*Nothing in this article should be considered legal or investment advice. Startup investments are always inherently risky and following the advice in this article will not necessarily reduce that risk.