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When you begin investing, two terms you frequently encounter are ‘stocks’ and ‘bonds’. While both are crucial components of financial markets, they serve different purposes in an investment portfolio. Understanding the difference between stocks and bonds is essential for you to make informed decisions.
Stocks are financial instruments that signify ownership in the company that issues them. When you buy a company's stock, you become a part-owner, proportionate to the number of shares you hold. Your investment in stocks can potentially yield two types of returns:
Dividends: These are a portion of the company's profits that are distributed to its shareholders
Capital Gains: You earn capital gains when you sell your shares for more than you paid for them
The returns from stock investment can come in the form of capital appreciation and dividends. As the company grows, it allows you to receive more dividend payouts and additional capital gains. It can serve as a regular income source and also provide relief during market downturns or periods of volatility.
Common Stock: They usually provide voting rights and variable dividends. There may be voting rights for the board of directors or capital appreciation.
Preferred Stock: While you don’t get voting rights, you receive fixed dividends, which are less common in India. Companies looking for long-term capital generally offer it. They carry a higher risk as compared to bonds.
Bonds are fixed-income instruments that represent a loan offered by you (as an investor) to a borrower (typically a government or corporation). When you invest in bonds, you are lending money in return for periodic interest payments and the return of the principal at maturity.
Understanding their specific characteristics is vital for anyone looking to diversify their investments or secure predictable income. Here are some of their notable features:
Principal Repayment (Maturity)
A core characteristic of bonds is the assurance that the initial amount borrowed (principal) will be returned to the investor on a pre-determined maturity date
Call Option
Some bonds include a "call option," which grants the issuing company the right to repurchase their bonds before the maturity date, typically at a price slightly above their face value
Pledge of Security
Bonds often come with a written and legally binding promise (pledge of security) from the issuing entity, often forwarded to a trustee, assuring repayment
Regular Interest Payments (Coupon Rate)
Investors earn income from bonds through regular interest payments, which are calculated based on a fixed coupon rate set by the issuing authority
Covenants
Bonds frequently incorporate covenants, which are formal agreements between the issuing company and its bondholders (managed through trustees). These covenants outline specific conditions and restrictions to protect the bondholders' interests.
Government Bonds: The central or state Government of India issues these bonds. They offer fixed interest with high safety and come in the form of T-bills, inflation-indexed bonds, etc.
Corporate Bonds: Companies issue these bonds to raise capital. They usually offer higher returns than government bonds and carry credit and default risks. The risks usually depend on the issuing company’s financial health.
Municipal Bonds: Local governments issue these bonds to fund public infrastructure projects. They may offer tax-free income but come with risks, such as interest rate fluctuations and credit risks.
Stocks represent ownership in a company, and bonds represent loans offered to entities. The table below summarises the main points of difference between stocks and bonds:
Feature |
Stocks |
Bonds |
|---|---|---|
Meaning |
They offer ownership of a company |
Acts as a loan you extend to an entity |
Type of Instrument |
Equity instrument |
Debt instrument |
Suitable For |
Investors seeking growth (price appreciation) and/or income (dividends) |
Investors who prefer lower risk and desire regular, guaranteed income |
Nature |
Ownership stake in a company |
Loan to the issuer (debt instrument) |
Returns |
Dividends and capital gains, but dividends are not guaranteed |
Interest and principal repayment upon maturity |
Risk |
Higher due to market volatility |
Lower, but includes credit and interest rate risk |
Maturity |
No maturity date |
Fixed maturity date |
Income Predictability |
Variable due to uncertain company performance |
Predictable with fixed interest payments |
Voting Rights |
Yes (in case of common shares) |
No |
Bankruptcy Priority |
Last (after bondholders) |
Before equity holders |
Investors commonly combine stocks and bonds in portfolios to balance between risk and return. While stocks drive long-term growth, bonds add stability and fixed income.
Diversification helps in mitigating risks while aligning investments with your financial objectives. Here is how you can structure your investment portfolio based on your risk tolerance:
Risk Profile |
Equity (Stocks) |
Debt (Bonds) |
Other Assets (Gold, REITs) |
|---|---|---|---|
Conservative |
30% |
60% |
10% |
Balanced |
50% |
40% |
10% |
Aggressive |
70% |
20% |
10% |
Stocks are preferable for those seeking higher returns and willing to accept greater risk and volatility. Bonds are preferred when you want stable income, capital preservation, and lower risk. Here are some use cases for both types of investments:
Stocks may be more suitable for building long-term wealth. They are also suitable for investors with a high risk tolerance and a long investment horizon.
Bonds are suitable for income generation, especially if you are a retiree. Additionally, bonds may be ideal if you wish to preserve capital and lower the overall volatility of your portfolio.
Understanding the difference between bonds and stocks is essential for building a well-rounded investment strategy. Stocks offer ownership with the potential for high returns but come with higher risk.
Bonds, on the other hand, offer fixed income with lower volatility, acting as a stabiliser in portfolios.
Rather than viewing them as competing instruments, see them as complementary. Together, they form the backbone of a diversified portfolio that caters to different financial goals, risk tolerance, and investment timelines.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
Sources
https://www.sebi.gov.in
https://www.nseindia.com
https://www.amfiindia.com
https://economictimes.indiatimes.com/definition/stocks?from=mdr
https://cleartax.in/glossary/stocks
https://economictimes.indiatimes.com/markets/stocks/news/sebi-extends-same-day-t0-settlement-cycle-by-six-months-till-november-1/articleshow/120737547.cms?from=mdr
https://www.axisbank.com/progress-with-us-articles/investment/demat-trading/difference-between-stocks-and-bonds
https://investor.sebi.gov.in/pdf/reference-material/corporatebonds.pdf
https://www.hsbc.co.in/investments/how-to-build-a-financial-portfolio/
https://investor.sebi.gov.in/securities-risks_trade_derivatives.html
https://www.kotaksecurities.com/investing-guide/articles/risk-of-investing-in-bonds/
Stocks represent ownership in a company, while bonds represent a loan to a company or government.
Generally, yes. Bonds are considered less risky due to their predictable income. However, they still carry risks, such as credit and interest rate fluctuation risks.
Yes. A well-diversified portfolio often includes both to balance risk and return.
Returns on bonds include periodic interest payments and any capital gain/loss on sale.
Formula: Current Bond Yield (%) = (Annual Coupon Payment / Bond’s Market Price)
Yes. Bonds can be a good long-term option for capital preservation and predictable income, especially for conservative investors.
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Posted on 18 Aug
Geetanjali Lachke
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