Difference Between Stocks and Bonds – Which Investment is Right for You?

There is a sharp contrast between stocks and bonds. Stock investment results in ownership. If Z buys 10 out of 100 company shares, Z becomes the owner of 10% of the company. Bonds are debt instruments. Bond investors become the creditors of the business.  

Understanding the intricate difference between stocks and bonds is necessary for optimum portfolio allocation.

Meaning of Stocks

Stocks result in ownership of a business. Issuing shares leads to dilution of ownership. An individual who invests in stocks is called a shareholder. A shareholder is entitled to the profits of the company. The profits paid to the shareholders are called dividends. 

Meaning of Bonds

Bonds are a form of debt capital. Investors become the creditors of the bond issuer and are paid interest. The interest paid on bonds are called coupons. The principal is returned after a bond matures. Companies can also repurchase the issued bond at a price higher than the nominal value.

Bonds vs. Stocks

Bonds and stocks are popular means of investment. However, there are several key differences between stocks and bonds. These stocks and bonds differences allow investors to diversify their portfolios. 

Parameter	Stocks	Bonds
Nature of investment	Stocks represent ownership. Investment in stocks results in ownership in proportion to the number of shares purchased.	Bonds are debt securities. Individuals who purchase bonds become creditors of the business.
Nature of returns	Returns earned on stocks are either in the form of dividends or earnings through the sale of shares in the secondary market.	Apart from zero-coupon bonds, these debt instruments earn returns in the form of interest. Bonds interest are called coupons.
Voting rights	Shares carry voting rights.	Bonds do not carry voting rights because they are a form of debt.
Bankruptcy	Shares are paid after the bonds are repaid if a company winds up its affairs.	Bonds are a form of debt. Therefore, they are paid before the shareholder.
Convertibility	Shares are not convertible into other asset classes.	Bonds are convertible into shares.
Risk	Shares are riskier than bonds because they sink and swim with the firm.	Bonds are a type of debt security. They are less risky because they have to be paid off before shareholders.
Tenure	Share investment can be held for as long as investors want.	Bonds have fixed maturity periods.
Classification	Preference shareEquity Share	Corporate BondsMunicipal BondsGovernment BondsZero-Coupon Bonds

Features of Bonds vs Stocks

Investors choose bonds or stocks based on their goals, risk tolerance, and returns. While both are popular, they have distinct features suited to different investors. Here’s a comparison.

Features of Stocks

1. Voting rights: Shareholders get voting rights because they have ownership of a business in proportion to the units of shares purchased. 

2. Risk factor: Investment in shares is risky because they sink and swim with the firm. If the company performs well, the shareholder enjoys capital appreciation. However, if a company winds up its affairs, shareholders are paid after third-party liabilities like Bonds.

3. Return: The high risk of shares leads to high yield if the organisation manages to deliver a good performance in the stock market. 

Feature of Bonds

1. Voting rights: Bonds do not have any voting rights.

2. Risk factor: Investment in bonds is considered less risky because even if a company winds up its affairs, bond repayments are priortised, since it’s a form of debt. 

3. Return: Return on bonds are lower than shares. Bond investors get interests called coupons.

Classification of Bonds vs Stocks

Stocks and bonds are further divided into different types based on their characteristics and purpose. 

Types of Stocks

Primarily, stocks can be classified into two types.

1. Preference shares: Preference shares get regular fixed dividends. These shares do not get voting rights but get preference during capital repayment. If a company winds up its affairs, these shareholders are paid before the equity shareholders but after the creditors.
2. Equity shares: These shareholders get dividends at the discretion of the company. Dividends paid are higher than preference dividends. Companies mostly issue equity shares.

Types of Bonds

There are different classifications of bonds present in the market. The most important types of bonds are listed below.

1. Corporate bonds: They are issued by non-government entities. An organisation issues this instrument to raise funds for the expansion and sustenance of business.
2. Municipal bonds: In India, municipal corporations or related entities may issue municipal bonds. It is often known as muni bonds.
3. Government bonds: It is issued by the central and state governments during a liquidity crisis.
4. Zero coupon bonds: They are available at a discounted price and repaid at the face value at maturity. No coupon is paid on these bonds. For instance, a zero coupon bond of ₹100 is issued at ₹90. After the bond matures, the company will repay ₹100. Although no interest is paid, the margin of ₹10 becomes the return on investment.

Impact of Inflation on Stocks And Bonds

A discussion on bonds vs. stocks is incomplete without understanding the correlation between the two. The relationship is due to variables such as inflation and interest rates. Investors may change the proportion of shares and bonds they own based on the prevalent market conditions. However, inflation has a key impact on both asset classes.

1. When Inflation Rises

When inflation increases, stocks and bonds share a positive relation. When inflation increases, the value of both shares and bonds falls.

2. When Inflation Falls

When inflation falls, stocks and bonds share a negative relation. The price of both assets moves in the opposite direction. If the value of shares increases, the value of bonds will decrease and vice versa.

Investors usually prefer an inverse relationship between stocks and bonds because it helps them to optimally diversify their portfolio and mitigate risks. 

Conclusion

Investors must understand the difference between stocks and bonds. The stock and bond difference enables individuals to optimise their portfolios through diversification. The contrasting features balance market volatilities. Moreover, investors can choose the asset that best fits their risk appetite. Cautious investors who wish to avoid market instability might prefer bonds over shares. Individuals willing to earn a greater return through analysed risk can prefer shares over bonds. However, a well-balanced portfolio must have a cushion against market fluctuations through debt investments. 
Financial planning apps can help investors maintain a well-balanced portfolio that ensures optimum returns.