Debt Vs. Equity Securities

by Kevin Johnston

When you buy bonds, you really loan your money to an organization in return for interest payments. That's why bonds are called "debt" securities. On the other hand, when you buy stocks, which is what "equity" securities means, you actually own a share of the company. That's why you buy what are called "shares." Each of these investments behave differently, and they carry their own risks.

Debt Security Advantages

When you buy bonds, the organization that issued the bond incurs a debt with you. This organization can be the government or a corporation, but either way, you hold their debt. The issuer of the bond must pay you before it pays dividends on stocks, except in the case of "preferred" stocks which come with a dividend commitment that is equal in status to the commitment to pay bond interest. Generally, however, your bond is first in line, even if the company gets liquidated in bankruptcy. You have the advantage of steady income from the interest payments.

Debt Security Disadvantages

Corporations can default on bond interest payments. So could the government if it did not have enough cash on hand. This would mean that you wouldn't receive your income, and the bond would lose value because investors would not find it attractive. Your bond can also lose value if interest rates rise above what your bond pays you. Newer bonds with higher interest rates than yours will be more highly valued in the market. If you try to sell your bond, you may have to sell it at a discount to make up for the lower interest investors will receive.

Equity Security Advantages

When you buy stocks, you own part of the company that issues the stock. You have a right to vote in shareholder meetings, either in person or by proxy. If the company grows its income and assets, your share of the company may grow as well. If the company pays a stock dividend, you can receive monthly or quarterly income as well as an appreciation in the price of your shares.

Equity Security Disadvantages

Bad news can sink your stock. If the media reports that the issuing company is having financial problems or even a scandal, investors may start selling the stock. Increased selling tends to drop a stock price. In the event the company runs short of cash, your dividends won't get paid until after bond holders have been paid. During bankruptcy, your stock could become worthless. Equities fluctuate in price daily, whereas bonds tend to be more stable.

About the Author

Kevin Johnston writes for Ameriprise Financial, the Rutgers University MBA Program and Evan Carmichael. He has written about business, marketing, finance, sales and investing for publications such as "The New York Daily News," "Business Age" and "Nation's Business." He is an instructional designer with credits for companies such as ADP, Standard and Poor's and Bank of America.

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