stocks or bonds
Any investor knows that the shares are more risky objects for investments as compared to the bonds, but they provide and higher income. The question is, justify the difference in yield additional risk associated with investing in stocks or bonds.
In theory, the owner of the ordinary shares may rely on two sources of income: dividend payments in the allocation of part of the profit among the shareholders of the company and increase of market value in the case of a sale of shares at a price exceeding the price of their purchase. None of these sources of income is not guaranteed. Firstly, it is not known, whether the company in the reporting period to earn a profit, but even in the case of a profit, it is not known what part of it will be allocated for payment of dividends. Secondly, there is uncertainty about the further movement of prices of shares, and there is no guarantee that the owner of the shares will have a great opportunity to sell them at a higher price.
Bond holder also has two sources of revenue: interest payments in the period of holding bonds (plus the return of its nominal value, if the note is saved to maturity) and increase in value, if the owner decides not to keep the bond until the date of maturity, and sell it at a price that exceeds the purchase price. If we consider the bonds issued by the government, municipal or corporate borrowers with high credit ratings, it is possible to tell, that in contrast to the shares of one of the sources of income on the bonds is guaranteed, namely regular payments of interest and return of principal at maturity. Therefore bonds is often called the instruments with fixed income, and therefore risk, associated with the ownership of bonds, compared with the risk of stock ownership.
The risk characteristics of the stocks or bonds
Under the risk of many investors understand the likelihood that they will lose or do not receive the expected level of income. As a rule, the greater the instability is characterized by the price of the asset, the greater the risk associated his possession. Therefore, in practice, the investment risk is most frequently measured by the standard deviation of returns (the degree of dispersion of the average level).
stocks or bonds In the United States, the standard deviation of annual profitability of shares amounts to slightly more than 20%. For comparison: the volatility of us long-term bonds is 10%, and Treasury bills - less than 5%. If the yield on a year to obey the laws of the normal distribution, it would be possible to expect, that on results of one year from the six-yield shares dropped to the boundaries of the interval 8.7% (arithmetic average of the yield of shares outstanding during the period 1900-2000) plus/minus 20.2%. Thus, over 101 years we have watched the age of 16, when the yield of the shares in the United States fell below the 11.5% and 16 years of age, when it exceeded 28.9%. In fact in the last century such years in the United States was 18 and 16, respectively, which is almost coming to a normal distribution.
Therefore, in addition to diversify its loan portfolio due to the inclusion in it of different stocks traded on the national market, investors should be advised not to forget about the possibilities of geographical diversification and enter in the portfolio of the shares of the foreign markets.
In the 20th century, a negative yield of the shares according to the results of two consecutive years was not unusual phenomenon for the world's stock markets. The average of such series of 2 unsuccessful years, occurred in 16% of all 2-year periods. Three consecutive years of falling at shares market there were more rare, but it happened and this - since 1900 in the 6% of all 3-year periods.
stocks or bonds, and confirmed that the shares in the long-term yields higher yields compared to the debt obligations, but investing in them is connected with high risk, and this pattern is true not only for the USA, but for the other developed countries of the world. Now you need to answer the question, compensates does a higher yield of shares of the additional risk, inherent in them.
stocks or bonds: the risk Premium
Investors are ready to take the extra risk and invest in shares, if they can expect to receive a higher income. The difference between the level of expected yield and rate of return on without risky assets (in their roles are government debt) is known as a premium for the risk (equity risk premium). It was she serves the interest of the investors in the shareholding of more risky than bonds shares. But the risk of this, as we can see, not illusion: the stock's volatility historically exceeds the volatility of the bonds, in addition, the stock market crises occur, which could deprive the investor of a significant part of its invested funds.
It is well known that many investors make the mistake of predicting the expected return by extrapolation of past results in future. This leads to the fact that in the periods of the growing market expectations of investors in regard to the amount of the risk premium in the future prove to be too optimistic, and in the periods of falling of the market investors have too gloomy look at the possibility of obtaining in the future additional income on investments in shares.
stocks or bonds: the risk Premium is one of the most important variables when making investment decisions. Today there is a tendency to further reduce the gap in the long-term return on shares and bonds. On the background of a decrease in expected future risk premium cost of shares of the modern stock market looks overpriced. Investors must come to the realization that after the Golden era of 1990-ies of the yield of the shares, most likely, will return to its normal levels, and that the current value of the stocks in many markets reflects exaggerated and unfounded expectations, based on the memories of the last bull market.
More modest expectations of future returns stock markets suggest increasing pressure on the cost of services for the management of assets and an increase in demand for active portfolio managers, capable to provide a higher yield compared with the strategy of "buy and hold" strategy and the index (passive) investment.
