Investors often put their money in both stocks and bonds with the objective to diversify their investment portfolio. Regardless, the extent up to which one should expose their portfolio to these investment options depends on multiple factors like risk appetite, time horizon and financial goals. Individuals, thus, need to be aware of bonds vs stocks and their underlying differences to ascertain the ideal investment ratio.
In this article
What are Bonds and Stocks
In a general sense, bonds are debt instruments. In other words, they are loans made out to an organisation. Being a debt, they appear as liabilities in a company’s balance sheet.
Bonds come in handy to raise funds, and they provide fixed returns in the form of interest. One must note that any organisation can issue a bond, including – governments, non-profit organisations, corporations, etc.
The bond market is known as the – credit market or simply the bond market. Generally, bonds are traded on stock exchanges. However, in terms of transactional volume, they are much lower than stocks.
Characteristics of Bonds
Some prominent features of bonds include –
- Repaying the principal – the principal is returned to the lender on a pre-fixed date. The time mentioned in the bond is known as the date of repayment or maturity date.
- Call option – It enables the issuing company to repurchase their bonds at a price that is above par value.
- Pledge of security – It serves as a promise in writing that is duly signed and sealed. After this, it is forwarded to the trustee by the concerned company.
- Interest payouts – The interest rate is popularly known as coupon rate. The interest amount is paid at regular intervals by the concerned authority that issued the bond.
- Covenants – Covenants serve as an agreement between a company and its bondholders through trustees.
Types of Bonds
Broadly there are four types of bonds, namely –
Fundamentally, stocks are instruments of equity investments, and each unit of share tends to represent ownership or stake in a company. They are considered to be quite liquid when compared to fixed income instruments.
When a business entity intends to raise money, they issue shares and invite investors to purchase the same. In exchange, the investors gain a percentage of ownership in the company, the right to vote and receive excess profits.
It must be noted that only sole proprietors, corporations and partnerships can issue stocks, which are put forth as IPO or during equity sales. This is indeed one of the fundamental bonds vs stocks points of distinction. Ideally, stocks are traded on the NSE or BSE.
Characteristics of Stocks
These are among the most distinctive characteristics of stocks –
- Ownership rights – A share represents a unit of ownership of the company. Shares also offer voting rights to stockholders.
- High profits – Investing in shares whose price keeps increasing facilitates capital appreciation.
- Risk factor – Stocks accompany a significant risk level, and so investors must factor in their risk appetite before investing in it. Alternatively, they can diversify their portfolio to spread out the risk.
- Returns – Shareholders generate income in the form of bonus and dividends.
Types of Stocks
It must be noted that stocks can be classified under two categories, namely –
In general, the types of stock classification include –
Nevertheless, to find out bonds vs stocks – Which one is ideal for an individual, one needs to factor in the differences between the two and analyse them carefully.
Difference between Bonds and Stocks
This table below highlights the primary difference between bonds and shares –
|Meaning||Bonds are funds that replicate the performance of the benchmark market index.||Stocks are instruments that focus on the prospect of ownership extended by companies in exchange for funds.|
|Type of instrument||Bond is a debt instrument.||Stock is an equity investment.|
|Issuance||Under normal circumstances, bonds are issued by the –
||Typically, stocks are issued by –
|Status||Bondholders serve as lenders to the company.||Individuals who hold the stocks are considered to be owners of the firm.|
|Returns||Investors receive a fixed repayment in the form of interest.||Stockholders earn dividends, but they are not guaranteed. It is because stocks are heavily dependent on the issuer’s performance.|
|Benefits||The bondholders are given priority during repayment and liquidation.||The stockholders gain voting rights.|
|Risk level||Bonds are rated by the credit rating agencies, and they mostly yield a fixed income. Collectively, these make bonds a less risky alternative for many.||In stocks, the associated risk level is relatively high. It is because investors do not earn fixed returns.|
|Tax burden||A bondholder is not necessarily exposed to any tax liability.||Shareholders may have to pay the Dividend Distribution Tax or DDT on their returns.|
|Participants||The major participants are the investors, institutional investors and speculators.||The main participants are market makers, traders and brokers.|
|Market||They are traded Over The Counter (OTC).
Generally, the bond market does not have any centralised trading or exchange system.
|Shares are traded through stock exchanges.
The stock market has a centralised trading or exchange system.
Individuals must factor in all these aspects to make an informed decision about investing. In turn, it will help to understand bonds vs stocks, which one is better for their financial requirements.