Bonds Vs Stocks: Understanding the Difference

A well-diversified investment portfolio strikes the right balance between equities and fixed-income securities. Such a portfolio can potentially shield you from market volatility and help you grow your wealth. Bonds, a type of fixed-income security, refer to financial securities that are issued by the government and companies to borrow funds to finance their projects. The bond market comprises certificates of deposits, corporate bonds, commercial paper, debentures, government securities, etc. Transactions in the bond market can be made between financial institutions, brokers, individual investors, government entities or large corporations. On the other hand, stocks, a type of equity, refer to the type of securities that give shareholders the ownership and a share in the profits of a company. Publicly listed stocks are tradable equity shares of a company that are issued to the general public and can be traded on a stock exchange.

Bonds

Bonds can be defined as fixed-income, variable or floating interest rate instruments that enable an entity (typically a government, municipality or corporation) to raise funds and fulfil its capital requirements. Bonds act as a loan from you to the entity, wherein you will be eligible to get an interest on the loan amount for a fixed tenure at periodic intervals, and thereafter, when held until maturity, the par value of the bond may be paid back to you in full. The interest payout and the tenure will vary on the type of bond that you invest in. As some bonds pay a fixed rate of interest and may guarantee the payment of the par value at maturity (or the end of the tenure), they are typically considered to be safer investment options than stocks. Also, an investment in bonds is less risky and less volatile in nature as compared to stocks. Due to their lower volatility and lower-risk profile, bonds usually offer lower returns than stocks. Even though bond prices can go up or down, they can still be a great addition to your investment portfolio as they help in balancing out riskier investments. There are various types of bonds that you can invest in. Some of them are:

Corporate Bonds

These bonds are issued by financial institutions or companies to fund their operations. If the company/entity issuing these bonds goes bankrupt during the bond period, you might not receive any interest payments and you may not even be able to get your full par value.

Government Bonds

These bonds are typically regarded as risk-free and are issued by a government. These bonds pay a fixed rate of interest at predefined intervals and return the face value on the date of maturity. The maturities for these bonds can range from 2 to 30 years.

Zero-coupon Bonds

These bonds, also known as accrual bonds, do not offer periodic interest payments, but they are offered at a discount, helping investors reap the benefits of the complete face value at maturity.

Convertible Bonds

These bonds have similar bond characteristics, such as maturity date, interest payout, credit rating, etc., but they give the option to the investors to convert or exchange them for a predetermined number of shares of the underlying company. Each bond comes with its own issuers, tenure and risk-return levels. If you do not want to invest directly in bonds, then you can look at various financial securities that are based on bonds, such as bond mutual funds, ETFs, etc.

Stocks

Stocks allow an investor to own a stake in a company. Stocks of publicly traded companies are traded on exchanges where investors/traders can buy and sell individual shares or a basket of shares. The stock market is volatile by nature. The variation of the prices of stocks can be due to the performance of the company and various other factors, such as social, political or economic events. When you sell the stocks at a higher price than your initial purchase price, you will be able to get positive returns on your investments. Similarly, if a company performs poorly, the value of the stock could fall below your purchase rate, and if you sold them, you would lose a part of your investment. Several companies from a variety of sectors and industries trade on the stock exchange. If a public-limited company wants to list their shares for the first time on a stock exchange, they can do so via an Initial Public Offering (IPO). Once listed, investors can then trade in the shares of these companies through the secondary market. There are several ways of earning money through stocks. One is through capital gains, i.e., by buying and selling the stocks and another way is by getting dividends from the invested stocks. Some of the stocks on the stock exchange may pay quarterly or annual dividends to the shareholders. Dividends are a portion of the profits of a company that are shared between the shareholders. But not all companies pay dividends to their shareholders. Stocks can be classified into various categories based on several factors such as:

Ownership

Based on ownership, stocks can be further classified into two categories - preferred stocks and common stocks or equity stocks.

Market Capitalization

Based on the market capitalization and the valuation, companies can be classified into large-cap, mid-cap, small-cap, and micro-cap stocks.

Dividend Payments

Some companies pay regular dividends to the shareholders, while others don’t. There are several types of dividends paid on the common stocks, they are – cash dividends, stock dividends, dividend reinvestment programs (DRIPs), special dividends, etc.

Sectors

Based on the sector and industry, stocks can be classified as Technology sector, Energy sector, Industrial sector, Healthcare sector, Banking sector, Financial sector, etc.

Bonds Vs Stocks: Similarities and Differences

Along with the above-mentioned points, there are other similarities and differences between bonds and stocks. While stocks consist of a company’s own capital, bonds can be considered as borrowed capital of the entity. Stocks and bonds are financial securities that are issued by corporations and companies to the public to raise money. However, stocks and bonds differ in their risks, returns and features. To generate profit in the stock market, the value of the invested stocks must appreciate, i.e., investors must sell the stocks in the stock market at a higher price than the price at which they were bought. Most bonds pay fixed returns (interest), known as coupons, to the investors at periodic intervals. And, when the bonds are held until maturity (predefined tenure), investors can get the par value back. Another important difference between the stocks and bonds are that, unlike stocks, there is no central place or a single physical exchange for trading or investing in bonds as they are traded directly between financial institutions. However, to trade/invest in stocks or bonds, investors must have a brokerage account. To understand the differences between stocks and bonds, the table below may help:

Frequently Asked Questions

Are bonds better than stocks?

Bonds are fixed-tenure investments that are typically less volatile and less risky than stocks. When held to maturity, bonds can offer predictable and consistent returns. Stocks, on the other hand, usually offer investors the potential for higher returns, however, they come with higher risks. A well-diversified portfolio needs to have a balance of both bonds and stocks to protect investors from the ups and downs of the market movement.

Can you make money from stocks and bonds?

Yes, bonds and stocks offer the potential for investors to earn money. By investing in shares, shareholders can potentially earn either from dividends and/or capital appreciation (selling the shares at a higher price than the average buying price). Most bonds, when held until their maturity date, help you earn regular interest and the repayment of the par value.

What are the types of stocks?

The two main types of stocks are common stocks and preferred stocks. Stocks can also be categorized based on their market capitalization, industry/sector, geographic location, etc.