You must have heard the advice “diversify your portfolio” from many investment advisors and people around you. They must have advised you to invest in riskier as well as less risky investment options. And for this, the terms that you must have heard the most should be Stocks and Bonds. Well, we already have two separate blogs giving you a basic idea about the stocks and bonds if you haven’t read them then read them first (click here & here to read) and then come back here for better understanding.
In this blog, we are going to talk about the difference between stocks/shares and bonds, how one is better than the other and which is the right option for you.
(Note: We are going to take in considerations only equity shares.)
Let’s analyze it from a different point of views to completely understand the difference between the two:
From Point of view of the Company
Stocks represent Sharing of the Ownership in the entity whereas Bonds represent debt for the entity.
Let’s understand this with an example: Suppose a company wants to raise ₹100 lakhs through the capital market. And the board of the company is choosing between stocks and bonds for the purpose.
Case 1. Assume board decides to sell Stock
The board decides to issue stock of ₹100 lakhs of ₹100 each. This would be done by a process called Initial Public Offer. The company will sell its shares in the open market to the public. For the company, it is the sharing of the ownership as the selling of stock means giving out the part in the ownership of the company. A person who buys the stock of the company becomes the part owner of the company, no matter how small. That’s why the stock is also called equity.
Case 2. Assume board decides to sell Bonds
If the board decides to sell Bonds then the company would be raising the debt on which the company has to pay interest regularly like every other debt. The interest rate is called the coupon rate. The person who buys a bond doesn’t become the owner of the company rather he is a lender to the company. At the end of maturity period of a bond, the company has to pay back the principal money back to the investors along with the interest paid in full.
From Point of View of the investors
Having an ownership stake in the company means that the investor shares in the profits and losses of the company too. If the company does well then the investor benefits from it and if company incur losses then the investor has to bear that loss in the form of fall in share prices or no dividend or in the worst case scenario, winding up of the company.
Stock markets are volatile and are very hard to predict especially in short term. Stock markets are therefore considered a riskier investment option as compared to other options that are much safer. However. But it is excellent for investors who have a long-term horizon and have the capacity to tolerate the short-term volatility.
On the other hand, bonds are much safer than the stocks but they lack the long-term return potential of the stocks. But bonds are good for those people for whom income is of priority. Income in bonds is regular in the form of interest whereas, in stocks, dividend is highly irregular. Dividend payment is completely dependent on the company’s performance, if there is profit then the company may choose to pay the dividend but in case of loss paying the dividend is not at all a liability but whereas in bonds whether there is loss or profit for the company, interest has to be paid. It is the liability for the company. Another reason why bonds are considered safer is that at the end of maturity period, the majority of the time investors receive full principal amount and even if their price fluctuates in the market, the fluctuation is not as volatile as in the case of stocks.
Which one is Right for you?
Well, the option that suits you will completely depend upon your investment period, investment objective, financial condition and risk capacity. A safer option is to always diversify your portfolio. Never put all your money in one place. Invest in products with different risk profile. This way your portfolio will be protected against fluctuations and losses.