If you want to be a better investor, you need to pay attention to this side of the market…
Every Wednesday, we bring you insights about the world of investing because we believe this activity can help you achieve financial freedom through wealth creation. Today, we will talk about the connection between stocks and bonds, and why you need to pay attention to both if you want to become a better investor. Excited to know more? Continue reading below!
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If you want to be a better investor, you need to pay attention to this side of the market… Whether you’re investing in stocks or bonds, you’re still buying a claim on a company. With stocks, you own a piece of the business. With bonds, you’re getting a piece of that company’s debts. While the difference between these two asset classes is simple enough, there’s more to it than meets the eye. Bonds and stocks also differ in how they make money for an investor. Stocks grow in resale value, while bonds pay a fixed interest over time. With the latter, you know exactly what you’re getting and can be used as a source of predictable fixed income over a long period of time. In the event of a bankruptcy, bondholders get paid back before stockholders, giving investors in this asset class a better chance of getting repaid. Meanwhile, in stocks, earning potential depends on the number of shares owned and the company’s financial performance. This means stockholders have to be aware of day-to-day share price fluctuations and consider what the overall market is doing and what it means for their positions. On the other hand, bondholders only need to know whether a company can stay solvent until its bonds mature. Understanding Credit and Equity We’re not saying bonds are a better asset class over stocks. We simply want you to know more about this because understanding how credit investments and bond markets work will enable you to become a better investor. According to Professor Joel Litman, Chairman and CEO of Valens Research and Chief Investment Strategist of Altimetry Financial Research, a company’s debt determines its chances of defaulting and growing in the future. By understanding how credit works, you’ll be in a better position to identify which stocks to buy or sell. Additionally, you can use this knowledge to buy corporate bonds, enabling you to diversify your holdings and augment your income. Lastly, knowing about the state of the credit market enables you to look out for signs of trouble in the equity market. With that said, what is the current state of the credit market? For the past several months, Professor Litman has kept tabs on credit covenants, a measure that protects lenders. Basically, a covenant is a part of a credit agreement that ensures companies aren’t taking on too much risk. According to Professor Litman, lenders have lost most of their negotiating power since the end of the Great Recession. As interest rates started to drop, lenders were left with little space to offer lower rates than other lenders. To secure better deals, they had to drop covenants. While this makes it easier for borrowers to access credit, lenders lose their protection. Even as interest rates rose in 2022, lenders weren’t able to negotiate stricter covenants. However, by 2023, that has started to change since consumer and corporate defaults started to rise. As a result, lenders aren’t willing to take on as much risk, leading to a rise in covenant protections on corporate debt deals. The bottom line? In a highly unpredictable investing climate, the best thing you can do for your financial well-being is to keep an eye on different markets. By understanding the connection between credit and equity, you’ll be putting yourself in a position to make well-informed financial decisions. Hope you’ve found this week’s insights interesting and helpful. During the peak of the COVID-19 pandemic, individuals and businesses alike were negatively affected by the deadly virus. Learn more about why the U.S. isn’t heading towards “Japanification” in next week’s article! |
