Difference Between Shares and Bonds: Which is Better for You?

Companies use bonds and shares (also known as stocks and equity) as financial instruments to raise capital for growth and expansion purposes. Further, the government also issues  bonds to acquire funds. You can include both equity and bond in your portfolio to earn returns while managing risk. While fluctuating stock prices are everyday news, changes in bond interest rates are a less frequent phenomenon. Stocks are popular equity instruments, whereas bonds are debt instruments.

As investors, you need to understand the difference between shares and bonds to be able to create an investment portfolio that best aligns with your financial goals, investment horizon, and risk-taking capacity.

Stocks come with a huge potential to create wealth, while the returns on bonds are fixed. Risk is also a significant differentiator between the two asset classes. While investing in equity might be a risky proposition, bonds offer you stability and low-risk. These are some basic differences between stocks and bonds.

This blog will aim to answer the bonds vs. stocks question, in detail. 

What are Bonds?

Bonds are a standardised and fungible unit of loan raised by a government or a corporation. Here, the entity issuing the bond is the one raising debt. When you buy these bonds, you become the lender who earns a fixed rate of interest periodically. These periodic payouts are called the “coupon payment.” When the bond matures, the issuer repays the borrowed principal amount, called the “face value.” 

For example, let’s say the government issues bonds with a face value of Rs. 1000 at a coupon rate of 4.5% and a maturity period of 5 years to raise funds for infrastructural development. 

You buy 20 of these bonds. For the next 5 years, you will earn 20 X 4.5%*1000 = Rs. 900 annually. In addition to this, at the end of this period, you will get back your fixed principal amount of 20 X 1000 = Rs. 20000.  

Furthermore, a bond can also be sold at a discount or a premium to the face value on account of certain macroeconomic factors.

Characteristics of bonds

While looking at the bonds vs stocks comparison, it is important to understand the characteristics of bonds:

• A major classification of bonds is done on the basis of the issuer. They can be government bonds, corporate bonds, or public sector bonds. Government bonds, being backed by the government, are considered to be nearly risk-free. Similarly, bonds issued by blue-chip corporations are considered to be a safe haven during recessionary times. 
• Bonds when classified on the basis of repayment priority at the time of default take the form of – Covered bonds, senior secured bonds, secured bonds, senior unsecured bonds, unsecured bonds and subordinated debt. In case of bankruptcy, covered bonds have the highest priority of being repaid.
• One of the major factors that determine bond price is the coupon rate of recently issued government bonds. If the coupon rate of newly issued bonds is higher than that of the existing bond’s coupon rate, then the price of the existing bond decreases to equalise the yields of the two bonds. The opposite happens when the coupon rate of newly issued bonds is lower.
• Credit rating is an important factor that helps investors evaluate bonds. This rating indicates the probability of a borrower to default on interest and/or principal payment. When the credit rating of a bond deteriorates, the price of the bond goes down as well.

To further your understanding on what is the difference between shares and bonds, let’s look at stocks in detail.

What are Stocks?

Stocks, or shares, are a type of security issued by a company that indicates fractional ownership of the company. For example, a company XYZ issues 10,000 shares. If you own 10 shares of the said company, it means that you own 10/10000 = 0.1% of the company. 

A company’s stock becomes available to investors when it goes public through an initial public offering (IPO) in the primary market. Post this, investors can get ownership of these stocks when the company issues a Follow on Public offering (FPO). One can also trade these stocks in the secondary market through stock exchanges. In India, there are two stock exchanges – NSE and BSE.

The income from stocks comes from dividends and capital gains. Dividends are payouts that a company makes to its shareholders as a part of its profit. However, they are not guaranteed as they are up to the discretion of the company and can stop at any time.

Capital gains are the gains from appreciation in the stock price. The gain is notional till the investor actually sells the stock and earns a profit. 

Characteristics of stocks

Understanding the characteristics of stocks is instrumental to know the meaning of shares vs bonds:

• In contrast to bonds, stocks usually sell at a high market premium to their face value. Face value is the nominal cost of creating the stock. 
• The prices of stocks are highly volatile as they are influenced by investors’ expectations of growth and future earnings. For example, if the last quarterly earnings of the company were high, investors would expect the company’s future earnings to be high, and the demand would send the prices upwards. To put it simply, ​​like all economic goods, stocks also respect the Law of Demand & Supply.
• As shares can be traded on the stock exchanges anytime during trading hours, they are relatively more liquid investments. 
• Stocks are broadly categorised into common stocks and preferred stocks based on voting rights and claims on assets and earnings of the company. 
• Common stock owners have voting rights, while preferred stock owners do not have this privilege. On the other hand, preferred stock owners receive dividends before common stock owners. 
• Further, preferred stock owners also have the priority of being paid in case the company goes bankrupt and is liquidated.

Bonds vs. Stocks: A Table of Comparison

While investors usually invest in both bonds and stocks to keep their portfolios diversified, it’s essential to know the difference between shares and bonds to limit exposure to the two as per their risk appetite and financial goals. 

The below table contains a list of parameters that differentiate the two financial instruments from each other:

Parting Thoughts 

Bonds and shares are both excellent instruments of investment. An investor must understand the differences in their risks and returns before creating a portfolio containing both or one of them. 

While equity comes with a high potential return at high risk, bonds offer a fixed income at low levels of risk. If you are a young investor with high-risk capacity, minimal expenses and responsibilities, then you could leverage equity-oriented investments in your portfolio. Whereas, when your financial responsibilities increase, bonds would be a great asset in your portfolio. 

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