The most significant demarcation that the capital market has is between the bond market and the share market. The biggest dilemma that an investor face is whether bonds of shares, what to pick for investment, and which will give him the best returns. Bonds and stocks are the two most popular choices of investment, each catering to separate investor groups. But they are very different in character and by the nature of return they generate. In this article, let’s discuss the differences between stock and bond market functions.
Stocks and bonds are the two most traded asset classes – both available for trading in various platforms.
What Is The Difference Between Stock And Bond Market?
Bond and stocks are traded in separate markets. A stock market is a place where corporate issue their stocks. On the other hand, bonds are treated as over the counter product.
The bond market is the specialised platform to trade bonds and other debt tools, also called debt or credit market. Corporate and governments issue bonds when they need to raise loans from the market. Against the bond, the company agrees to pay an interest or coupon to the lender. And so, bonds guarantee a stream of steady, although nominal, income to the investor. But these are apparently free from market volatility, which is why investors add bonds to their portfolio as an instrument for diversification.
Bonds are issued both by the corporates and government. Treasury bonds that are issued by the government pay bi-annual interest. These are often of fixed tenure, say of five or eight years and have a maturity date. But some bonds are traded in the secondary market like stocks. Investors include bonds in their portfolio, aiming at long-term investment to achieve financial independence.
Finding the right bonds for investment requires research and investigating the best deals available. Investors compare their returns or yields of bonds to shift their funds to those with higher return and good ratings.
Two main categories of bonds trade in the market.
Corporate bonds: Private companies issue bonds to raise loans from the market, often to find finance for new projects, building new plants, revamp infrastructure, purchasing equipment, or for expanding business.
G-sec or government security bonds: The issuer is the government of India to fund various development projects. Reserve Bank of India often acts as the issuer and custodian of government bonds.
Stocks trade in the exchanges like BSE and NSE. These are centralised platforms to facilitate trades by bringing buyers and sellers together. Companies issue their equities in the stock market to raise equity capital from the market. Equities are different from bonds, which are debt tools. By selling equities promoters decentralise some portion of their stakes in a company to private investors.
Stock prices are sensitive to market volatility and investing in stocks involve high risks. But stocks are highly liquid instruments, which means they frequently change hands and traded for profit. These exchanges take place in the stock market through stock exchanges. The market comprises of companies, traders, investors, arbitrageurs, brokers, sub-brokers and various other players. SEBI plays the role of regulator and is responsible for monitoring the equity market for any types of unethical practices.
Apart from the fact that stocks and bonds are fundamentally different financial instruments, here are a few more differences to take note of.
Maturity date: Bonds, being debt instruments, have a maturity date. Stocks are freely traded in the market and don’t have any maturity date. Stocks are issued in the primary market as IPOs and traded in the secondary market based on their values.
Returns: Returns on bonds are low as compared to stocks. But the return on the bond is fixed, whereas, dividend on stocks is a portion of the company’s profit and depends on performance. If the company performs poorly in a year or earns less profit, it can choose not to pay a dividend to shareholders.
Risk: Stocks are high at risk. Bonds are considered less risky when it comes to valuation and return. Bondholders are considered lenders and hence, have the first claim on the company’s asset if it goes bankrupt.
Stock prices are subject to market volatility. Its price can rise and fall with events like market news, sector performance, economy, and even political situations.
Stocks And Bonds Reaction In The Market
Bonds are secured investment and investors select bonds when they consider a long-term investment. Stocks are traded in high frequency and often to profit from the price difference. Stock and bond markets often act in the opposite direction. That is, when the stock price goes up, bond prices usually go down.
When the economy is booming, stocks generally do well. In a booming economy, the purchasing power of consumers increases so, they make more purchases, increasing profit earning for companies. This gets reflected in the company’s balance sheet and cause stock prices to soar. It means stocks prices adjust better with inflation and give a better return to investor’s money.
Which is better, bonds or stocks?
Since we have answered the question of difference between stock and bond market let’s understand which one is better. It depends on your personal investment goals. Here are a few points that will determine your nature as an investor.
- Your financial goals – long-term and short-term
- Risk tolerance
- Return outlook
- Speed of investment or trading
If you are more of a traditional investor with a conservative outlook to risk-return and low-risk tolerance, choose bonds for your portfolio. Trading in stocks demands more involvement and high-risk tolerance, but the promised return is also high. Moreover, stock prices also adjust for inflation which is an advantage over bonds.
Age of the investor is also an important determining factor. Bonds are prescribed to senior investors or when you want to save for retirement, children’s education, or to buy an asset. However, if you are young and don’t bother too much about market fluctuations, but you intend to build wealth, stocks are perhaps a better choice.