We may refer to stocks and bonds collectively as investment instruments. But though we often pair their names, they are varied in nature. A comparison of Bonds Vs Stocks shows how they are different. The risk involved, returns, and benefits are different for each of them.
What are Bonds?
Bonds are high-security debt instruments where you lend money to a company or a government organization. You give the loan amount to the company for a set period of time. In exchange, you get a commitment from them for repayment and regular interest earnings. The bond issuer returns your money upon maturity of the bond. Bond investments also generate a fixed income for the investor over the life of the bond.
Companies issue bonds to finance their ongoing operations, upcoming projects, or acquisitions. Governments sell bonds to raise funds for supplementary revenue from taxes. When you buy a bond, you become the debtholder for the ‘issuer’ or the entity issuing the bond.
Most bonds are low-risk investments in comparison to equities. They are key components of a balanced investment portfolio. Bonds hedge the risk posed by volatile investments like stocks. They offer a steady stream of income while preserving capital.
Organizations issue bonds for investors in primary markets. The corpus the company collects is for fulfilling capital requirements and funds business operations. Companies may also use the funds for infrastructural development or manage acquisition expenses.
The amount at which you purchase bonds is known as face value or principal. This amount is returned to you at the end of a fixed tenure known as the maturity period. Consequently, issuers may pay a percentage of the principal amount as periodical interest. The company may give you interest at a fixed or floating rate.
Once you acquire bonds of an entity you have the legal and financial claims to its debt fund. Borrowers are therefore liable to pay you the entire face value of bonds upon completion of a term.
How Does the Bond Market Work?
Before comparing Bonds vs Stocks let’s look at how the bond market works. The bond market in India is of two types – retail and wholesale markets. Products traded in these markets are bonds (or debentures), government securities, and preference shares.
Retail Bond Market
Retail bond trading takes place similar to share trading on the stock exchange. It is executed on the CM (Clearing Member) segment on NSE and the F group (Fixed Income Securities) on BSE. You can trade in bonds by using the relevant ISIN numbers or scrip codes on the normal NEAT/ ODIN software.
Wholesale Bond Market
The wholesale or WDM (Wholesale Debt Market) trading takes place between institutions. Trading takes place on the basis of the prices you negotiate. WDM has separate segments for government securities and corporate bonds (including preference shares). The bonds include fixed tenure bonds and perpetual bonds (up to the year 2099). It also has taxable interest bonds and tax free bonds (interest earned on these bonds is tax-exempt). The Corporate Bond category also allows trading of Preference shares which have a fixed maturity period.
For each transaction, initially, each party puts forward indicative prices. Then the negotiation happens to reach a final price. Once both parties agree on the negotiated amount the order is confirmed. Settlement takes place through BSE or NSE and payment is done through RTGS. The traded securities are then delivered. The settlement of bonds depends on the type of security traded. Deal sizes may be Rs. 5 crores onwards for institutional trades. It can come down for individuals and be around Rs. 10 lakhs only. Brokerage for bond trades is chargeable in basis points (1/100th of a per cent).
Bond prices change in response to interest rate or interest rate perceptions. Other macro-economic factors like fiscal deficit, demand, and supply, etc. may also impact it. Generally, bonds are not quoted on the basis of their price. They are quoted based on their yield or returns.
What are Stocks?
Stock describes a share in the ownership of a company. The pricing of each share is based on a certain amount which is a percentage of the overall worth of the company. When you buy shares of a company, it gives you ownership of that small portion of the company’s worth.
How does the Stock Market work?
You must understand the working of the stock market to compare bonds vs stocks. A stock exchange is a platform for conducting the trading of financial instruments like stocks and derivatives. In India, the Securities and Exchange Board of India (SEBI) regulates the trading activities of a stock exchange. To conduct trade on a stock exchange, all participants must register with SEBI and the stock exchange. Trading activities on a stock exchange range from buying and selling instruments, brokering and issuing of shares by companies, etc.
Listing of the Company in the Secondary Market
The shares of a company are listed for the first time on the Indian secondary market through an Initial Public Offer (IPO). At this time, investors can bid for a portion of stocks depending upon their risk appetite. The allotment of stocks is done before listing and investors get their share depending on the total number of investors.
Trading in the Secondary Market
Upon listing of the company, its stocks trade in the secondary market by the investors. Subsequently, buyers and sellers transact in the stock marketplace for making profits and may sometimes suffer a loss.
The magnitude of stock investors is large and not all of them are capable of conducting transactions on their own. Also making them available at one location is necessary. Therefore, stockbrokers and brokerage firms conduct trade on their behalf. Stock Brokers are broking entities registered with the Stock Exchange. They serve as intermediaries to help the investors conduct transactions at the exchange.
Passing of your order
Your broker passes the buy or sell order on to the exchange. It is matched with an inverse order such as sell for a buy order or buy for a sell one. When the seller and the buyer agree upon a price point, the exchange of stocks takes place. Or you can say the order is then confirmed.
The stock exchange confirms order details according to the final transaction amount. Subsequently, upon ensuring there is no fault in the transaction the exchange facilitates the transfer of ownership of the shares. This process is known as Settlement. You receive a notification on email or a message of confirmation once this takes place. The communication is sent to multiple parties including the investor, brokerage order department, the exchange floor traders, etc.
Earlier the settlement process was completed in weeks but now it takes only T+2 days to materialize. This means that if you trade today, your Demat account will reflect the shares in two working days. You must also be aware that all your investments in the share market are subject to market risks. It is advisable to seek expert guidance before you invest in stocks.
You may also like to read about Primary Market vs Secondary Market
Bonds vs Stocks – Difference Between Bonds and Stocks
Following are the main differences between Bonds and Stocks:
|Basis of comparison||Bonds||Stocks|
|Definition||Bonds are financial instruments that refer to the loan taken by an issuing body from a holder. It comprises a promise to pay back the principal amount at a later date with interest.||Stocks are instruments that issue interest of ownership by any company in exchange for funds.|
|Issuers||Government institutions, financial institutions, companies, etc.||Corporates|
|Status||Bondholders are the lenders to the firm||Stockholders are the stake owners of the company or firm|
|Risk Levels||Relatively low||High|
|Form of Return||An interest that is paid regularly||The dividend which is not guaranteed|
|Additional benefit||Liquidation and preference in terms of repayment||Shareholders possess voting rights|
|Market||Over the Counter||Centralized/Stock Market|
|Type of investment||Debt||Equity|
|Time of maturity||Fixed at the time of purchase||Depends on investors|
|Participants||Investors, speculators, institutional investors||Market maker, floor trader, floor broker|
|No. of Types||12||4|
Bond or Stock – Which is the Better Investment Option?
An investor may allocate his funds between shares and bonds depending on a number of factors. These include the time horizon for investment, income requirements, and risk-taking capability. But, if we compare which is better between bonds and stocks we must look at more aspects. Both stocks and bonds are good financial instruments to park funds. They generate higher returns than other investment options. Both bonds and stocks help investors in making short-term gains. Investors can also choose to stay invested for the long term in both. While constructing your portfolio you should consider both shares as well as bonds. It is advisable to create a balanced portfolio to enhance the possibility of returns.