Stocks vs Bonds

Introduction

When considering investment opportunities, you generally have two primary asset classes to choose from: stocks and bonds. Each of these investment types offers distinct benefits and carries its own set of risks. The most fundamental difference between stocks and bonds is that the money you invest in stocks buys you ownership in a company, while the money you use to buy a bond is essentially a loan to the bond issuer.  (Asness, C.S., 2000.)

This blog explores these two options, with the goal of helping you make informed investment decisions that match your financial goals and risk tolerance.

Stocks

Stock represents a tiny share of ownership in a company. When you buy a stock you buy a share of ownership of the company and you become a shareholder of the company. The more stocks you have the more ownership stake lies with you.
In India stocks are traded on Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE).

Characteristics of Stocks:

1. Ownership rights: Stock provides a unit of ownership to the shareholders that often comes with voting rights.
2. Higher returns: Stocks provide higher returns to its investors i.e. 16% annually on an average. Investors make money from capital gains (selling stocks at a higher price than bought) and dividends (company earnings distributed to shareholders).
3. Higher Risk: Stocks are more volatile i.e. they can go up and down in their values more quickly which makes them riskier assets. (Fama, E.F. and French, K.R., 1993.)
4. Higher Liquidity: Stocks are considered very liquid as they can be easily bought and sold in the stock market.
5. SEBI Supervision: Stock market is under the supervision of Securities Exchange Board of India to protect the interest of the shareholders.

Types of Stocks:

1. Equity Stocks: These are also referred to as common stocks. These stocks provide voting rights to the shareholders. They come at the bottom in the priority list of repayment during liquidation.
2. Preferred Stocks: As the name suggests, these refer to the type of stocks which is prioritised in dividend payment as well as in payments during liquidation. They carry a fixed rate of dividend and do not provide ownership rights to its investors.

Bonds

Bonds are debt securities through which companies and governments raise debt capital from the investors. When you invest in bonds, you do not get any ownership in the company of which you are buying the bonds. Bonds provide you a fixed rate of return referred as coupon at regular mentioned intervals and involves repayment of principal (except in case of perpetual bonds). Bonds can be issued at par, premium or discount and can be redeemed at par or premium. Some bonds like Zero Coupon Bonds do not provide any coupon payments and are instead issued at discount and redeemed at par and the difference is the earnings of the bondholders.

Characteristics of Bonds:

1. Fixed Maturity Date: Bonds normally have a predetermined maturity date except for perpetual bonds which never matures.
2. Repayment of Principal: The principal amount is repaid to the investors on predetermined dates.
3. Fixed Return: Bonds provide a fixed rate of returns to the investors unlike stocks.
4. Lower Risk: Bonds carry lower risk as compared to stocks as the returns are fixed and not fluctuating. (Fama, E.F. and French, K.R., 1993.)
5. SEBI and RBI regulations: Government Bonds are regulated by RBI while Corporate Bonds are regulated by SEBI.

Types of Bonds:

On the basis of Issuers:

1. Government Bonds: These refers to those bonds which are issued by the Central and the State Government to raise debt capital from the public. These bonds are safe as backed by the government and provide a low yield. 
2. Agency Bonds: Agency bonds are the bonds issued by the government agencies such as municipal agencies. These are also considered as safe and provide low yields. However they have slightly higher risk and return as compared to government bonds.
3. Corporate Bonds: Corporate Bonds are the bonds issued by corporations or companies to raise debt capital for the purpose of either expansion or business operation. They carry higher risk and returns as compared to the above two types of bonds.

On the basis of listing:

1. Listed Bonds: Bonds that are listed on recognized stock exchanges like the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). Lower returns and lower risk as compared to listed bonds.
2. Unlisted Bonds: Bonds that are not listed on the stock exchanges and traded over the counter or privately. Higher returns and risk as compared to unlisted bonds.

Difference between Stocks and Bonds:

Particulars	Stocks	Bonds
Meaning	Equity instruments that provide an ownership share in the company.	Debt instruments where investors lend money to issuers.
Type of Returns	Potential capital gains and dividends(Not guaranteed and fixed).	Regular payment of interest known as coupons.
Risks	Higher risk than bonds.	Lower risk than stocks.
Returns	Higher than bonds and fluctuating.	Lower than stocks but fixed.
Volatility	Higher than bonds.	Lower than stocks.
Voting Rights	Provides voting rights to the investors.	No voting rights for the bondholders.
Maturity	There is no maturity.	Bonds have a fixed maturity.
Priority in case of liquidation	Stockholders are paid after bondholders.	Bondholders are paid before stockholders.
Marketplace	Traded on regulated stock exchanges like NSE and BSE.	Can be traded on NSE and BSE and as well as over the counters.

 

Conclusion:

In conclusion, both stocks and bonds present unique advantages and risks that cater to different investment strategies and risk tolerances. Stocks offer ownership in a company, have potential for high returns through capital gains and dividends and come with higher volatility and risk. Bonds, on the other hand, provide fixed returns through interest payments, are less volatile, and carry lower risk, making them a safer investment option. 

The choice between stocks and bonds depends upon an individual’s financial goals, risk appetite, and understanding. For a balanced portfolio, you should include both asset classes to diversify risk and optimise returns. You should understand the fundamental differences between stocks and bonds in order to make informed investment decisions that align with your own financial objectives.