Owning Vs. Lending… Whats the difference?

Whats the difference between owning vs. lending? Lets begin our answer to that question with another question. What is investing?

Investing is putting “capital” at risk for a period of time in the “hope” of getting more. So investing involves money, time, risk and (hopefully) reward. Before we can invest we need some money we can afford lose (never invest the rent or grocery money). Before we can invest there must be adequate time before we might need the money (you can't invest if you need the money tomorrow). We choose to invest because we must since, over time, the value (the buying power) of our money will decrease (yes the system is rigged against savers). We choose to invest because we “hope” we will end up with more money after some time but in order to do so we must take on “risk”. What do we mean by risk? Simple… We could lose (some or all of) our money!

Although it may seem to the novice investor that there are thousands of options, in fact there are really only five options when it comes to a choice about where to put our money to work. There are equities (ownership in companies) there are interest rates (lending money in bonds) there are tangibles (futures such as corn, soybeans, crude, gold and silver), there is real estate and and there are collectibles. The goal of all investors is to be in the right side (bull or bear) of any of these investment options should he/she choose to participate. In this article we will look at primarily the differences between the first two investment options: equities and interest rates.

Once we have some money to invest we need to decide how much risk to take on. We must decide how much (money) we can afford to lose. Usually this means we must choose to be either an “owner” or a “lender”. Owning something (almost always) involves more risk.

Lets consider the lender first since practically everyone is one. Do you have a bank account? Then you are a lender. Your bank pays you a small amount of interest for lending them your money. Your “deposit” in the bank is a loan and that makes you a lender. Your deposit is also (in most cases) guaranteed by the FDIC and is therefore virtually a “risk free” investment.

Now lets consider the owner. When you purchase an “asset” you become and owner. Ask any home owner and they will tell you there are big benfits to being an owner. You get to reap the benefits of “appreciation”. But there are also more risks for instance if the plumbing breaks, you can't just call the landlord and tell him to fix it, you are responsible for getting it fixed. The concept here is: ownership involves higher risks and rewards than lending does.

In the world of “tradeable instruments” or “securities” we can be an owner by purchasing stocks or we can be a lender by purchasing bonds. With stocks, there are no guarantees. If we own stock and it goes up, we can sell it at the higher price. If it goes down, we take a loss when we sell. Since we are “owners” we reap the benfits of appreciation and suffer the consequences of depreciation.

While we own the stock, we may also get dividends. But dividends are not guaranteed either. Some companies don't even pay-out dividends. The thing to keep in mind is that companies may or may not issue dividends and the amount of dividends payed out to stock holders may vary. If the company goes belly-up… stock holders are at the bottom of the list of who gets paid back. Stock holders can and do… lose everything.

When we purchase bonds, we are lending the bond issuer, which could be a company, a local government etc. our money. They agree to pay us back a fixed interest rate over time. Bonds are less risky than stocks because we receive an income stream in the form of an interest payment for the life of the bond or until it matures. However, the value of our bond can and will vary. If for any reason we need to sell our bond, (sell the remaining income stream) we will only get the current market value for it which may be more or less than what we initially lent the issuer. We sell our bond in the Bond Market which is HUGE! Its many times the size of the equity or stock market.