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I have the concrete problem of choosing which of a bond and a stock I should sell. Below, the price of the stock is shown in red, while the bond is black. The rest are various indices in Scandinavia (where I'm at).

Which considerations should I be making w.r.t. selling the stock or the bond?

At first, looking at only the graphs of the stock and the bond, I thought it made most sense to sell the stock, since (it seems like) I've actually gained some money if I choose to go this route, as the stock is at an all time high. However, compared with the indices, it hasn't done splendidly. Would it make more sense to look at the detrended time series? Is my stock going up simply due to inflation and the overall movement of the market? If I looked at the detrended development, the red graph (I suspect) would be fairly level, however the black would be going down.

Does this mean I should be selling the bond, since it is actually loosing value by staying at the same price?

I am completely new to this, so sorry for any major misconceptions on my part.

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    if you calculate the (log) returns of the instruments then you can use the officially published inflation rate less the calculated return to work out your answer. – MD-Tech Dec 12 '17 at 9:58
  • @MD-Tech Thanks, however I know how to detrend the data (sort of). I would like to know how to interpret the (detrended) data: for instance, has the bond actually fallen in value by staying level? – Bobson Dugnutt Dec 12 '17 at 11:32
  • Stock prices tend to include a consensus estimate for future earnings. If you think the underlying company will do poorly, and so do other investors, the stock price will already be lower today. (Efficient market hypothesis, which holds quite well for large publicly traded companies). Actually, so do bond prices, which is why their price is so stable - the expected interest is also very predictable. – MSalters Dec 13 '17 at 8:47
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Does this mean I should be selling the bond, since it is actually loosing value by staying at the same price?

All else being equal, the price of a bond should stay relatively flat. Bonds are priced based on their future cash flows (periodic coupon payments and redemption value at maturity). The only reasons that a bond price would fluctuate are changes in the underlying interest rate of the currency and credit risk changes in the bond issuer (company or government). Investors don't buy bonds with the expectation that their price will increase significantly; they buy them for near certain coupon payments.

Stocks, on the other hand, are much more volatile. Their future cash flows (dividends, plus any proceeds from a acquisition or stock buyout) are much less certain. Investors buy them with the expectation that their value will increase (or that their dividends will increase, although a dividend payment temporarily lowers the price of a stock since it's cash out the door of the company).

Which considerations should I be making w.r.t. selling the stock or the bond?

You should consider what you want to be invested in going forward. Can you tolerate higher risk (price fluctuations) with the potential of higher returns? Then stick with the stock (or cash out your gains and find a different stock). Would you rather have more certain cash flows with little to no chance of a dramatic increase in the price? Then stick with the bond.

  • Thanks! My only question now is if I should detrend the time series or not: a) Is the stock performing "badly" (i.e., has it been a comparably bad investment) if it hasn't had the same increase over time as the indices? b) If we detrend the time series, the bond will show a downward trend (correct?). Does this mean that it is now worth less than when I bought it, considering that the graph above is flat? – Bobson Dugnutt Dec 12 '17 at 15:17
  • You'd need to include the interest payments to compare the total performance of each. They have completely different cash flow structures, so price can't be compared directly. You can already tell that the stock performs worse than the index, so I don't see what de-trending will tell you. I wouldn't call it a "bad" investment, though. – D Stanley Dec 12 '17 at 15:32
  • If you include the coupons in the value of the bond, then the bond values generally increase. If you don't, then values generally increase between coupon payment, and then spike downward at coupon payments. Zero coupon bonds values generally appreciate reasonably steadily. – Acccumulation Dec 13 '17 at 19:04
  • @Acccumulation True, I was thinking mostly of par bonds (and clean price, not including accrued interest). Discount bonds would tend toward the par price (100) as time passes. – D Stanley Dec 13 '17 at 19:39
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Does a stock/bond that stays at level price lose money over time?

This question can be broken up into two pieces:

  1. Can any stock or bond lose money over time?

Bond

At maturity the face value (or par value) of the bond is paid back to the holder. For example, if a bond was issued by issuer ABC which had a face value of $100, then after all the interest payments were made, and the issuer didn't go bankrupt, then the issuer would repay the bond holder the amount of the bond. It is called the 'face value' as back in the day when physical paper was used, the amount was printed on the face of the certificate.

However, this doesn't mean that face value is what you paid for it. Bonds can be bought at a "premium" (above the par value) and at a "discount" (below the par value). Often this premium and discount reflects the prevailing rates of the bond market compared to the amount that the issuer is paying, and the bond market's assessments of the issuer's risk of default (not being able to make the payments).

So - if you bought a bond at a discount or 'par' and the issuer did not default, and you were willing to hold the bond to maturity, you would not 'lose money'. If you bought bonds at a 'premium' then you would not receive the difference between the premium and the par value, but hopefully that would be made up by the interest payments between the time that you purchased the bond and maturity.

Stock

Stock on the other hand doesn't 'mature' in the same way that bonds do. Instead investors are supposed to receive a perpetual stream of dividends, and the price should generally reflect the market's expectation of future dividends.
Because stock is generally more risky than bonds (the amount of the dividend can be varied; bond holders have higher priority in liquidation, etc.) investors generally expect a higher return from stock than from bonds.

However, a company could decide to simply decrease or stop paying dividends altogether (though could continue to pay bond holders) which in turn would cause the market price to drop. As a result, if you had to sell rather than wait for the company to turn-around (which could be a very long wait) you would potentially lose money.

  1. Does a stock or bond that stays at level price lose money over time?

Financing

It really depends on another factor which is - where did the money come from to acquire the position? If the money is borrowed (e.g. from your broker in a margin account)? If so, then it is likely you will have to pay your broker interest on that money. If the amount of that interest exceeds the interest or dividends you receive from the stock or bond, then you are losing money by holding the position. If the net interest is still positive, then you are not losing money.

Inflation

As the government prints more money, the value of currency is diluted. As a result, we have a rate of inflation (e.g. many central bank targets are about 2%). One can argue that you're losing money if all of the returns (interest payments from the bond or dividend payments from your stock including financing and taxes) from your position are below the rate of inflation (e.g. 2%).

Some would argue that one should therefore invest in an asset like gold which will increase in value with inflation, though when you sell your position you will likely have to pay capital gains tax and there may be other places where you will get a better return.

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