Know the Difference Between Shares and Bonds
Financial experts recommend that investors should have a diverse portfolio where they invest in both equity and debt. It can allow them to mitigate their losses if one asset class goes through a bear market. Among numerous ways to diversify, experienced investors use equity and bonds. Therefore, it is important to understand how shares (stocks) and bonds differ fundamentally.
Your trading account will help you invest and trade in the equity market. But, how do you invest in bonds? As a beginner, you must have questions such as this before you start investing in other asset classes than equities. Hopefully, by the time you finish reading this, you will have most of your basic questions answered about shares and bonds.
How is money raised with shares and bonds?
Firstly, both shares and bonds are used by corporations and governments to raise money from the public. Equity, also called share or stock, allows the investor to own a stake in the company, entitling you to receive returns on your investments based on company performance and market forces that affect the stocks’ prices.
On the other hand, buying a bond is similar to lending money to someone with a promise that you will earn fixed returns (interests) at periodic intervals and get back the principal amount in a predefined future date.
You can best understand the fundamental difference between these two asset classes by looking at how they raise money.
A company raising money with shares
ICF Ltd. was a food processing company founded by Ashish and Imran in 2015. Initially, both the partners used their savings and took a business loan to start the company. As the business grew, it was time to expand operations. However, it was not possible to take any further loans, so the founders decided to sell the shares of the company to raise capital.
So, ICF issued an initial public offering (IPO), a process that allows listing a company in the NSE or BSE and raised capital from the public. Now, whoever buys ICF stocks has an ownership interest in the company. With time, a particular investor’s investment will gain in value as the company becomes more profitable. If you have a share trading account or Demat account, you can invest and trade in the stock market.
A company raising money with bonds
In the above example, ICF can also decide to issue bonds to raise money from the public. However, bond investment works differently from stocks.
A bond has par value (e.g. Rs. 1,00,000), and the return or interest that you earn is called a coupon (e.g. 5%). If the par value is Rs. 1 lakh and the coupon rate is 5%, you will receive Rs. 2,500 twice a year or Rs. 5,000 annually on your investment until maturity.
A bond is a debt instrument; therefore, you don’t have to worry about how the company performs. You get fixed returns on your investment and the principal amount back on maturity, irrespective of the company’s financial situation.
Types of bonds and stocks
Generally, there are four types of bonds; they include:
- Corporate bonds
- Municipal bonds
- Government bonds
- Zero-coupon bonds
On the other hand, stocks can be categorised according to market capitalisation (size), sector, and growth. These can be blue-chip, mid-cap, small-cap, value stocks, defensive stocks, growth stocks etc.
Bonds vs. Shares: Major differences Basis Bond Stock Type of returns Bonds provide fixed income through interests. The value of a stock changes based on the performance of the company. Dividends are paid but not guaranteed. Level of risk Low High Returns Low High Issued by Governments, public and private corporations, financial institutions Public and private corporations Type of instrument Debt instrument Equity Voting rights No Yes Participants Retail investors, institutional Retail investors, traders, investors, speculators brokers, floor traders Different types 12 types 4 types Bonds vs Stocks BONDS: STOCKS: Issues of debt Issues of a stake of ownership in a company Debt that is made with an investor for cash in exchange for payouts of interest A claim to a company’s assets and earnings that often gives the investor voting rights and pays dividends Typically traded over the counter (OTC) Typically traded through a central exchange (like NYSE) Generally lower risk, lower reward Generally higher risk, higher reward Since 1929 have earned around 6% each year Since 1929 have earned around 10% each year Can be made as corporate, municipal, or treasury bonds Are issued by companies at a stock exchange as IPOs How to buy bonds and stocks
To invest in stocks you need a share trading account along with a demat account. However, a demat account is enough to invest in bonds in India. Among bonds, government securities, popularly called G-Secs, are one of the safest. You can also invest for the long-term – up to 40 years in these bonds.
Contrary to popular belief, you don’t need a lot of money to invest in government bonds; in fact, you can start with as low as Rs. 10,000. Using a demat account, you can also invest in treasury bills (T-Bills), which is also a popular type of government bond. T-Bills are available for 91 days, 182 days and 364 days.