Stocks vs Bonds

Updated on April 24, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Stocks Vs Bonds Meaning

A stock represents a collection of shares in a company entitled to receive a fixed dividend at the end of the relevant financial year, mostly called the company’s equity. In contrast, the bond term is associated with debt raised by the company from outsiders, which carry a fixed return ratio each year and can be earned as they are generally for a fixed period.

Stocks Vs Bonds Differences

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They are used for making quick money or even keeping their investments since the prospects of growing money are relatively higher in this case. However, other macroeconomic factors also impact the performance of these stocks or bonds, which also needs to be kept in mind.

Stocks Vs Bonds Explained

A stock indicates owning a share in a Corporation representing a piece of the firm’s assets or earnings. Any person willing to contribution to the capitalContribution To The CapitalContributed capital is the amount that shareholders have given to the company for buying their stake and is recorded in the books of accounts as the common stock and additional paid-in capital under the equity section of the company’s balance sheet.read more can have a share if it is available to the general public.

Bonds are loans that are secured by a specific physical asset. It highlights the amount of debt taken with a promise to pay the principal amount in the future and periodically offers them the yields at a pre-decided percentage.

Both are known as financial instrumentsFinancial InstrumentsFinancial instruments are certain contracts or documents that act as financial assets such as debentures and bonds, receivables, cash deposits, bank balances, swaps, cap, futures, shares, bills of exchange, forwards, FRA or forward rate agreement, etc. to one organization and as a liability to another organization and are solely taken into use for trading purposes.read more and utilized by retail and institutional clients to park their funds with expectations of getting higher returns. Though these avenues can be used for making short-term gains and closing out the trade, many are also holding onto them in the long run as a form of investment.

Bonds issued by the government are extensively used and depict the country’s financial stability. If the yields offered are less, the nation is in a good position to pay off its debt and does not need everyone to lend to them and vice-versa.

In the end, it depends on the investment objective and risk appetiteRisk AppetiteRisk appetite refers to the amount, rate, or percentage of risk that an individual or organization (as determined by the Board of Directors or management) is willing to accept in exchange for its plan, objectives, and innovation.read more of the investors and how long they are willing to part away with their funds. When constructing a portfolio, either or both these instruments can be included to enhance the possibility of returns.

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Stocks Vs Bonds Infographics

Let’s see the top differences between investing in stocks vs bonds stocks vs bonds.

Stocks-vs-Bonds Infographics

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Thus, the above chart shows clearly the differences in stocks vs bonds returns, risk and there importance.

Example

Let us assume an example where an investor invests in both stock and bonds. This helps him to diversify his investment so that the portfolio remain balanced. He invest in some shares of Company X Ltd, and also some bonds of the same company.
However, the company performance deteriorates slowly and a few year down the line, the stock prices fall drastically. So, here, the investor loses money that are invested in the stocks. Thus, he suffers heavy losses. But the part of his portfolio that are invested in bonds, continue to get the interests, providing him a regular income. Finally the company goes into liquidation. As a result, the investor gets back his investment in bonds but does not get anything from the stocks.
This proves that stock may give higher return but bonds a safe investment.

Key Differences

These fundamental differences highlight the stocks vs bonds returns, risk, and usefulness.

  1. A stock is a financial instrument issued by a company depicting the right of ownership in return for funds provided as equity. A bond is a financial instrument issued for raising an additional amount of capital. These are issued by government agencies and private organizations offering periodic interest payments and principal repayment after the duration.
  2. Stocks are treated as equity instruments, whereas bonds are debt instrumentsDebt InstrumentsDebt instruments provide finance for the company's growth, investments, and future planning and agree to repay the same within the stipulated time. Long-term instruments include debentures, bonds, GDRs from foreign investors. Short-term instruments include working capital loans, short-term loans.read more.
  3. Stocks are issued by various companies, whereas Bonds are issued by corporates, government institutions, financial institutions, etc.
  4. Regarding return on bonds vs stocks the returns on stocks are dividends that are not guaranteed and depend on the company’s performance. Despite making substantial profits, if the board of directorsThe Board Of DirectorsBoard of Directors (BOD) refers to a corporate body comprising a group of elected people who represent the interest of a company’s stockholders. The board forms the top layer of the hierarchy and focuses on ensuring that the company efficiently achieves its goals. read more wishes to deploy profits elsewhere instead of distributing a dividend, such decisions cannot be questioned. On the other hand, bonds have fixed returns that have to be paid irrespective of the borrower’s performance since it is a debt amount. Thus, there is a guarantee of returning the amount in bonds.
  5. Stockholders are considered owners of the companies and are given preference in terms of voting rights on important matters. Bondholders are creditors to the company and do not get voting rights.
  6. Regarding the stocks vs bonds risk, the risk factor is high in stocks since the returns are not fixed or proportional, whereas bonds have fixed returns making them less risky. In addition, bonds are also rated by credit rating agencies, making them more structured before considering the investment opportunity.
  7. The stock market has a secondary marketSecondary MarketA secondary market is a platform where investors can easily buy or sell securities once issued by the original issuer, be it a bank, corporation, or government entity. Also referred to as an aftermarket, it allows investors to trade securities freely without interference from those who issue them.read more in place, ensuring centralized trading instead of bonds in which trading is done Over the Counter (OTC).
  8. Stockholders may have to pay DDT (Dividend distribution tax) in case the returns are received, further curtailing the returns received, but bonds are not exposed to such tax burdens.

Stocks Vs Bonds Comparative Table

Basis of Comparison StocksBonds
MeaningThese are instruments that highlight the interest of ownership issued by the company in exchange for funds.A financial instrument that highlights the debt taken of the issuing body towards the holders and a promise to pay back at a later stage with interest.
IssuersCorporatesGovernment institutions, Financial institutions, Companies etc.
StatusStockholdersStockholdersA stockholder is a person, company, or institution who owns one or more shares of a company. They are the company's owners, but their liability is limited to the value of their shares.read more are the owners of the companyLenders to the firm
Risk LevelsHigh since it depends on the performance of the issuerRelatively low since bondholders are prioritized for repayment.
Form  of ReturnDividend but not guaranteedThe interest which is a fixed payment
Additional benefitHolders get the Right to VotePreference in terms of repayment and also on liquidationLiquidationLiquidation is the process of winding up a business or a segment of the business by selling off its assets. The amount realized by this is used to pay off the creditors and all other liabilities of the business in a specific order.read more.
MarketCentralized/Stock MarketOTC (Over the CounterOver The Counter)Over the counter (OTC) is the process of stock trading for the companies that don't hold a place on formal exchange listings. The broker-dealer network facilitates such decentralized trading of derivatives, equity and debt instruments.read more)

Pros And Cons

Let us look at the pros and cons of stocks vs bonds risk and return.

Stocks
Pros –

  1. It is suitable for investors who are ready to take more risk.
  2. If stock analysis is correct, they have the capacity to earn excess returns.

Cons-

  1. There is a chance of losing money, which implies risk is more.
  2. Equity holders are the last ones to get paid if company is liquidated.
  3. They are highly volatile.

Bonds

Pros-

  1. Good for investors whose risk appetite is low.
  2. They are sure to get their money back if the company is liquidated.
  3. Bonds are less volatile than stocks.
  4. It is a reliable source of income through coupon payments.

Cons

  1. Not suitable for investors who want higher return.
  1. There is no excess return.

Recommended Articles

This has been a guide to Stocks Vs Bonds meaning. We explain its key differences, and pros and cons along with a comparative table, infographics & example. You may also have a look at the following articles for gaining further knowledge in corporate finance –