Know the Difference Between Shares and Bonds
Financial experts recommend investors to have a diverse portfolio that includes stocks and bonds. Therefore, it is important to understand how shares (stocks) and bonds differ on a fundamental level.
Your share trading account will help you invest and trade in the equity market. But, how do you invest in bonds? You may have questions such as this as a beginner to the investing world. 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 or even governments to raise money from the public. An equity, share or stock allows you to own a stake in the company where you get returns on your investments based on company performance and market forces that affect stock 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.
Examples
The fundamental difference between these two asset classes can be best understood 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. The business grew and it was time to expand operations. However, it was not possible to take any further loans so they decided to sell the shares of the company to raise capital.
So, ICF issued an initial public offering (IPO), a process that allows you to list your company in the NSE or BSE, and raised capital from the public. Now, whoever buys ICF stocks has ownership interest in the company and his 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. Bond investment works in a different way 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 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.
Types of bonds and stocks
Generally, there are four types of bonds; they include:
- Corporate bonds
- Municipal bonds
- Government bonds
- Zero-coupon bonds
Stock on the other hand can be categorized according to market capitalization (size), sector and growth. If you have plans to start investing in the stock market (also called equity market), start with India’s best trading account from IIFL. With an IIFL demat and trading account, you can trade in equities, bonds, commodities, mutual funds and currencies from a single platform. You also get expert research, recommendations and strategies to trade with confidence.
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
All you need is a demat account to invest in bonds. To invest and trade in the stock market, you need a share trading account along with a demat account.
Among bonds, government securities which are 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.
IIFL has one of the best trading accounts among brokerage houses in India and you can get access to a wide range of stocks, bonds, commodities, derivatives and currencies. Open a free IIFL demat account today and enjoy zero account opening charges, zero AMC for 1 year and cashbacks up to Rs. 10,000.