THERE’S A CERTAIN swagger that goes with saying you own stocks. The label “shareholder” conjures some combination of savvy gambler and calculated risk taker. You own a piece of the action and if a company hits the jackpot, you get to brag; if it tanks, you can always whistle and change the subject to “Game of Thrones” reruns.
Company bondholders, by contrast, get no such bragging rights. In fact, many investors who love stocks couldn’t tell you the difference between a company bond, a bail bond and those U.S. Savings Bonds Aunt Winnie used to dole out with boxes of marzipan candy.
Yet the smart investor won’t want to overlook this potential income source, as company or corporate bonds provide a stabilizing element to many portfolios – especially those weighted towards aggressive holdings.
So what’s the difference between owning company stocks and bonds? That comes down to whether you’d rather be an owner or a lender. Stock entitles you to a stake in the company and its dividends, while a bond puts you in the equivalent role of a banker financing the operation. Some investors prefer bonds because they come with a guaranteed yield (also known as the coupon rate) and the return of the principal.
“Like with any bond, a corporate bond is simply a financial security recognizing that investor is loaning money to a corporation,” says Robert Johnson, a finance professor at Creighton University’s Heider School of Business. “A bondholder can only receive what is promised – nothing more.”
Stocks of course come with no such guarantee, though they do dangle the prospect of handsome returns should share prices take off: something bond investors can only witness from a wistful distance.
“That’s why bonds are often referred to as fixed income securities,” Johnson says. “If everything goes as planned, a bondholder knows exactly what she will receive and the return she’ll earn if she holds the bond to maturity. If you bought a bond of a wildly successful company – like Microsoft Corp. (ticker: MSFT) or Apple (AAPL) – and you held to maturity, the best you could hope for is to receive the promised interest payments and the full return of the principal amount.”
Three ratings agencies assign grades to company bonds, with AAA or Aaa being the highest, also known as “prime.” “Corporate bonds offer a decent source of income as part of a diversified portfolio,” says Andrew M. Aran, partner at Regency Wealth Management in Ramsey, New Jersey. “They offer a higher yield than Treasury bonds with modestly higher risks for the investment-grade variety – those with rates BBB or higher.”
But if the fears of some economists pan out and the U.S. enters a recession, the BBB border line could become shorthand for Big Bad Bear crossing.
“We also see a risk with bonds rated in the BBB area, which is the lowest rung of investment grade,” says Collin Martin, managing director and fixed income strategist at Schwab Center for Financial Research. “During a recession, there’s a greater risk that some of these corporate bonds could be downgraded by the major rating agencies to junk, which would likely send their prices lower.”