Q. I recently received some money via an inheritance, and have started looking at investment options. I have never really had much to do with investing before. Can you please explain the difference between shares and bonds? Sarah – Subiaco
A. Certainly. Shares represent ownership in a company. The benefit to the company is that they can use your money to finance growth and development, hopefully earning greater profits as a result. The benefit to you comes via dividends, which are payments out of the profit the company makes, as well as the potential for selling the share at a higher price in the future. Depending on the risk involved with the company and its activities, you expect greater returns with higher risk. Keep in mind that companies aren’t required to pay dividends, and start-up companies often don’t pay dividends for a few years as they grow!
Bonds represent a loan – often to the government – where you give them money now, in return for regular coupon payments, plus the face value of the bond at the end of the set term (the bond’s maturity date). In Australia the government bonds are called Exchange-Traded Treasury Bonds and include the coupon interest payment every six months.
Because the coupon interest rate is fixed, bonds can sell at either a premium or discount in relation to their face value, depending on changes in the interest rate for other investments over the life of the bond (if the return on other investments rises compared to the price of the coupon rate, the value of the bond decreases).
Government bonds will offer lower returns than corporate bonds and shares, because there is basically zero risk that the government will default on the loan. As with any investment, lower risk investments generate lower returns.
There are numerous variables when investing in either shares or bonds, so if you are serious about investing your inheritance, I would recommend speaking to an advisor.