Debt and equity instruments are used to invest in corporations.

There are two principal ways in which a company can obtain additional finances necessary to operate or expand. One is by selling equity and the other is by taking on debt. Selling equity can be accomplished through the sale of common stock. Preferred stock has characteristics of both debt and equity. Debt can be taken on in the form of short-term and long-term loans or through the issuing of bonds.

1. Risk
Equity holders take on a greater risk than debt holders. This is because by investing in a company, you are in effect tying your fate to the fate of the company. Bondholders do not make this same commitment, and only stand to lose if the company does so poorly, it is unable to pay back its creditors.

Legal Rights in Bankruptcy
In a bankruptcy, debt holders have a first priority over equity holders. This is because people who loaned money to the company have a greater expectation of return than those who invested in the company.

Potential Return
o If a company shatters expectations and does very well, equity holders are in a better position than debt holders. This is because debt holders have an agreement with the company that they will be paid back a set amount of interest for their loan. Equity holders on the other hand have no guaranteed return, but the potential to reap big dividends if the company does well.

Control
o Because equity should be thought of as ownership, it also comes with some measure of control. With commons stocks, this takes the form of voting rights. Each share is entitled to one vote, and this allows shareholders in publicly traded companies to have a say in who is on the board of directors. The board of directors is responsible for picking the CEO and other managers and determining the major direction of the company. Bondholders and other equity holders do not have this ability because they are merely lenders.

Personal Investment Strategy
o Some people are more inclined toward risk than others. Therefore, some people may be more inclined to purchase debt instruments like bonds than equity instruments like common stocks. However, most investment professionals recommend a portfolio with both stocks and bonds. Equity instruments are expected to have greater returns in the long run, but have much greater swings, while debt instruments produce lower returns with fewer swings. It is recommended that as you get older, you put more of your investments into debt and less into equity.