What Is the Difference Between Shares and Bonds

What Is the Difference Between Shares and Bonds

Shares vs Bonds

In the financial markets, broadly there are two types of investment instruments available viz. equity and bonds. While bonds investment offer fixed and steady return over time, they are not too good at wealth creation. Bonds risk does exist but the risk is not as high as in the case of equities, which is why the yields on bonds are relatively lower. When you look at the difference between shares and bonds, risk is one of the key criterial you look at.

In any portfolio, there should be a mix of shares and bonds. While bonds offer the steady returns and stability to the portfolio, equity shares offer the wealth creation over the long run. Here we look at the share and bond differences across various parameters like risk, returns, taxation, liquidity etc

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Table of Content

  1. Shares vs Bonds
  2. Investments 101 – Concept of shares and bonds
  3. Key differences between bonds and shares

Investments 101 – Concept of shares and bonds

Lets understand the concept of share market and bond. We start with shares or equities or stocks; they are different words but mean the same. They refer to risk capital. When an investor invests in the shares of a company, they get part ownership of the company, irrespective of how small the purchase is. In the case of shares, the liability of the investor is restricted to the face value of the stock bought in the event of liquidation. Investors can invest in equity shares either thorough the primary IPO market or secondary markets. Shares provide investors dual returns of dividends and capital gains when the shares are sold at a profit. Equity shares have historically generated the highest returns for investors in the long run, subject to investors creating a diversified portfolio.

Let us now turn to bonds or fixed income instruments. Bonds are debt instruments that pay a fixed rate of returns on an assured basis and then return the principal amount (face value) on the completion of the tenure of the bond. Bonds are typically issued by governments, municipalities, companies, financial institutions etc. Unlike debentures, which are short term debt instruments, bonds can be medium term and long term debt instruments. Bonds are relatively less risky than shares making them an excellent addition to the portfolio of risk-averse investors. Some of the popular bonds include government bonds, corporate bonds, zero-coupon bonds, variable rate bonds etc.

Key differences between bonds and shares

You can understand the key differences between bonds and shares on the following parameters.

  1.  Let us first look at the risk aspect (which is defined as the volatility of returns on the investment). Obviously, investment in shares is considered to have the highest risk as compared to any other instrument since it is a participation in ownership of the company and is exposed to various risk factors that can be macroeconomic or industry specific or company specific. In comparison, the bonds are relatively safer, especially government bonds, as the investor is assured of the return of their investment at the time of redemption and the regular income. However, corporate bonds and bonds issued by NBFCs can carry an element of default risk.
  2. We now compare bonds and equities in terms of returns. The returns from stocks are dual in the form of dividends and capital gains arising at the time of sale of investment. Normally, shares are volatile in the short run but tends to create more wealth in the long run. On the other hand, the returns on bonds are in the form of fixed interest and there could be an element of capital gains at the time of redemption if the bond was bought at discount in the secondary markets. Gold bonds appreciate with the price of gold.
  3. In terms ownership, owning equity shares in your demat account is akin to owning a part of the company and you are part of the risk and performance of the company in question. However, in the case of bonds, the ownership is absent and the relationship between the issuer of the bond and the investor in the bond is that between a debtor and a creditor. Bonds do not provide ownership or stake in the company, although one exception is convertible bonds that can be converted into equity at a future date subject to satisfying certain conditions.
  4. 4) Let us turn to liquidity, which is a key factor if an investor wants to exit the position in a bond or a stock. In the case of equities, demat shares are fairly easy to sell. All you need is a trading account to sell the shares and the funds can come into your bank account in T+2 days. Of course, the condition is that the stock should be liquid in the stock markets, but that is an issue only in the case of some penny stocks today. In the case of bonds, only government bonds are liquid. Other bond instruments like corporate bonds and gold bonds do not have too much of secondary market liquidity. You need to wait either for the redemption or for the intermittent redemption window opened by the issuer. One way to overcome this problem of liquidity is to invest in debt funds instead.
  5. Let us turn to the major participants in the equity and bond markets. In the equity market there are foreign portfolio investors (FPIs), mutual funds, insurance companies, retail investors, HNIs; apart from brokers and market makers. The bond markets in India is largely dominated by banks, institutions and corporates and the retail participation is a lot more limited in the bond market as compared to the equity markets.
  6. Finally, let us look at some additional aspects of both the instruments. One way the equity investors differ from bond investors is that equity investing gives ownership and voting rights to the investors. The bond holder is not an owner of the issuer company, but just a creditor who has lent money. Obviously, not being the owner, the bond holder does not have voting rights in the Investment in stocks provides the investors with ownership of the company and voting rights at AGMs. Bond holders also get priority over equity investors in the event of winding up of the company. Click here to know more about redemption of debentures.

There is a quick element taxation to understand. Interest on bonds and dividends on equity are treated as other income and taxed at the peak rate applicable to the investors. In case of capital gains on equities, long term capital gains (over 1 year) is taxed at 10% flat without indexation while short term gains are taxed at 15%. For bonds, the cut-off for LTCG is 3 years. LTCG is taxed at 20% with indexation benefits while STCG is taxed at peak rate applicable.