Advantages of Corporate Bonds vs. Stocks
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Corporate Bonds |
Stocks |
 Strong potential returns
with lower risk |
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 Greater certainty
of recurring income |
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 Greater protection of principal |
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 More investment options |
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Strong potential returns with lower risk
Individual Corporate Bonds vs. Stocks
A key advantage of individual corporate bonds vs. stocks is that they can achieve
strong investment
returns and
limit your downside.
While corporate bonds typically do not experience the price volatility of stocks, a
variety of factors can cause corporate
bond prices to move, which can create opportunities to invest in corporate bonds with
strong upside.
Being able to quantify your downside is an important tool for individual bond investors.
A key reason why there is less
downside to bonds vs. stocks is that a bond is a contract between the issuing company
and the bondholder. The company
must pay interest on the bonds on specific dates, and it must return the face value of
the bond ($1,000 per bond) at
the bond's maturity date. Both of these factors stabilize the value of corporate bonds.
Stocks don't provide the same
level of commitment to shareholders, as a company can suspend dividend payments, and
investors have limited recourse
other than selling the stock. We saw this during the COVID-19 crisis, as some of the
largest companies in the world,
including Disney, Royal Dutch Shell, Boeing, and Ford either suspended or reduced their
stock dividends.
In addition
to having contracted interest and principal payments, corporate bondholders are senior to
common and preferred stockholders
in a company's capital structure. This is most relevant in the event a company files
for Chapter 11. In such
cases, bondholders often will not be made whole; however, since they are senior to
stockholders, bondholders are guaranteed
to have a larger recovery of their principal than stockholders, who are often completely
wiped out.
Greater certainty of recurring income
Bond issuers have contractual obligations to bondholders that are much more stringent
than obligations to shareholders.
This starts with the bond issuer's obligation to pay interest on time, typically on a
semi-annual basis. If a company
stops paying its interest to bondholders, the issuer could be deemed to have caused an
'event of default,' which could
enable bondholders to take certain actions to obtain their interest payments and/or a
return of their principal.
Stocks do not have these same obligations, and companies can, at the drop of a hat,
suspend dividend payments to stockholders,
as happened during the COVID-19 crisis in 2020.
Many retirement investors need to know that recurring interest or dividend payments
will continue to be paid, which is
why corporate bonds can be a more compelling investment opportunity for retirement
investors seeking a reliable income
stream. It wasn't too long ago that General Electric had a AAA credit rating and
was one of the world's most valuable
companies. After years of underperformance, in October 2018, GE cut
its quarterly dividend to $0.01 per
share. If this can occur at one of the world's most valuable companies, no
stockholder is immune from dividend cuts
or suspensions.
Greater protection of principal
When investors buy stock of a company, there is no guarantee that the company will repay
the investor anything. The stock could
go up and it could go down depending on the company's performance and market
conditions.
As noted above, the face value of a corporate bond is $1,000. When a bond
matures, the issuing company owes the bondholder
the face value of the bond he purchased. This provides corporate bond investors with a
much higher level of principal security
relative to stockholders.
In addition, bondholders are more senior in a company's capital structure than
stockholders. In the event of a bankruptcy,
stockholders typically get wiped out where bondholders can recover a portion of their
principal depending on the value
of the company and what other debt obligations it has.
Being senior in a company's capital structure and having a contractual obligation to
receive the bond's face value at maturity
provides corporate bondholders a greater level of principal protection than that of
stockholders.
More investment choice than the stock market
On any given day, people can invest in nearly 9,000 individual corporate bonds,
approximately double the number of publicly
traded stocks. This enables investors to build portfolios that are well suited to
their investment objectives and
risk profiles. For example, a more aggressive investor could favor high-yield
bonds and longer-dated investment grade
bonds. More conservative investors may stick to bonds of higher credit quality
and, to reduce pricing volatility,
limit the time to maturity of investment-grade bonds. We like to say "there's a
corporate bond for everyone."
We expect this enhanced level of investment choice in bonds vs. stocks to continue,
as corporate bond issuance has remained
strong and the number of companies going public through initial public offerings (IPOs)
has waned, falling 67% from 1999
to 2017. The number of publicly traded stocks decreased 45% from 1996 to 2015.
While 2018 corporate bond issuance fell to $1.3 trillion vs. $1.6 trillion in 2017, the
previous-record 2017 issuance levels were
a 3.5x increase from 1997. In Q4 2018, companies sold over six times more in bonds vs.
stocks. At the end of 2018, there was approximately
$9.2 trillion of corporate bonds outstanding, which is 2.4x the size of the municipal bond
market and nearly 60% the size of the
United States Treasury market.
In the wake of COVID-19 in 2020, many companies needed to borrow heavily to finance
losses as a result of many industries being
shut down or significantly restricted. As shown in Figure 1, monthly corporate bond
issuance surged to record levels in April
and May 2020. Monthly investment-grade corporate bond issuance exceeded $250 billion
in both April and May 2020. Across
these two months alone, companies issued over $500 billion in corporate bonds, which was
over 40% of all 2018 investment-grade
corporate bond issuance.
While many companies have work to do to support their new levels of indebtedness, the
significant issuance shows a robust corporate bond market
that can serve investors
across varying investment objectives and risk profiles.
Figure 1: Annual and Monthly Corporate Bond Issuance Volumes*
* Source: SIFMA bond issuance data
Another perspective
This article reviews our rationale for owning corporate bonds vs. stocks. For
a perspective on dividend stocks, you may
find the following websites of interest:
Dividend Aristocrats
Dividend Kings
Monthly Dividend Stocks