What Is the Difference Between Bonds and Stocks?
When considering investment opportunities, stocks and bonds are usually two of the first to jump into peoples’ minds. Whilst both are used to potentially generate a return, the way in which they accomplish this is very different. So, what is the difference between stocks and bonds?
In this article, we will help you gain a better understanding of bonds vs stocks by highlighting some of the key differences between these two instruments before explaining how to invest in stocks and bonds in 2022.
Table of Contents
What Are Stocks and Bonds?
Before we examine the differences between stocks and bonds, let’s firstly familiarise ourselves with the meaning of stocks and bonds.
Stocks
When investors buy stocks, they are buying a portion – or a share – of a company, meaning that, as a shareholder, they essentially become a part-owner of the company in question.
Therefore, when it comes to stocks, the success and, consequently, the return of your investment is dependent on the success of the company. The better the company performs, the better your investment will tend to do. Of course, the opposite is also true.
Bonds
Bonds are what is known as a “fixed-income” instrument. When you buy a bond, you are lending money to the issuing entity – typically a corporation or government - which they undertake to repay you on a fixed date in the future, together with any applicable interest in the interim.
Straight away, a key difference between stocks and bonds should be apparent – namely that, with a bond – the repayment amount is fixed from the outset and the future success of the bond-issuer will not impact this figure.
However, that does not mean that bonds are without risk, something we will look at more closely later.
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The Differences Between Stocks and Bonds
Now we understand the meaning of stocks and bonds, what are their main differences and which is a more suitable investment for you?
Income vs Capital Gains
Whilst the purpose of both investments may be the similar – to generate returns – stocks and bonds achieve this in very different ways; one via regular, fixed income and the other mainly by capital gains.
Bonds generate income for investors by way of interest payments, known as coupon payments, which are fixed at the beginning of the bond’s term. These coupon payments are made regularly until the bond’s maturity; how regularly depends on the bond in question. Once the bond has matured, the full amount the bond was originally sold for, the principal, is returned to the investor.
Many stocks also make regular payments to shareholders in the form of dividends. Unlike coupons, these payments vary from one period to another and may not be paid at all. Generally, young, fast-growing companies tend not to pay dividends (or to pay smaller ones), whereas larger, more mature companies do – providing they make a profit.
In order for an investor to profit from stocks, they need to sell their shares for a higher price than they originally paid for them, or to collect dividends. This means that - unlike bonds, which have a fixed rate of return baked into them – stock market investors do not know beforehand exactly how much money their investment will generate for them, if it generates anything at all.
With bonds, there is a predetermined limit to how much your original investment will generate. With stocks, there is, in theory, no limit to your potential returns.
Debt vs Equity
When you buy a bond, you are lending money to the bond-issuer. In this way, a bond can be thought of like an ‘IOU’ between the investor and the bond-issuer. Bondholders have no influence over the borrowing entity or any stake in their business - they are simply a lender who must be repaid.
This is another key difference between stocks and bonds. Buying shares in a company buys you equity in the company; as a shareholder, you are a part-owner. This means that - as well as sharing in the future success, or failure, of the company – you also usually receive voting rights, enabling you to have your say on how the company is run.
Risk of Bonds vs Stocks
In the first highlighted difference between stocks and bonds, we said that whilst bonds have a fixed rate of return, stocks have no limit to how much they can potentially return.
However, it is important for anyone considering bonds vs stocks as an investment to understand that the risk profiles of the two are very different. With their higher potential return, stocks also tend to have higher associated risk.
Stocks
The main risk associated with investing in stocks is that, after you have purchased them, the share price falls. The main reason for this happening would be if a company underperforms, but it could also be caused by a variety of other unrelated factors.
For example, if a company’s reputation is tarnished by a scandal, it operates in an industry which has become unpopular or they have been the victim of new regulations which hamper their business.
Bonds
Although bonds are typically seen as the “safer” investment between the two, it is important to remember that they are not without risk. Bonds carry the risk of default, in other words, the risk that the bond issuer does not pay you back the agreed upon interest or the principal.
A bond’s level of risk really depends on the bond issuer. At one end of the spectrum, you will find investment grade bonds; bonds which are issued by entities with a high credit rating and are, therefore, deemed low risk. However, these bonds will also have a lower interest rate.
At the other end of the spectrum, you have junk bonds; these bonds will have higher returns, but they are issued by entities with low credit ratings and, therefore, carry a higher level of risk.
Nevertheless, when weighing up the risk of bonds vs stocks, it is also worth considering that if a company goes into liquidation, its bondholders will be prioritised over shareholders when distributing any remaining funds.
Bonds vs Stocks: Which Is the Better Investment?
So, which is better, bonds or stocks? There is no real answer to this question mainly because, as we have seen, stocks and bonds are two very different instruments which can be used to achieve different goals.
Bonds are potentially more suitable for income investors, whereas stocks are more suitable for investors targeting growth.
However, it is not necessarily a question of stocks or bonds. Many successful investors will tell you that a healthy portfolio is made up of a mixture of both stocks and bonds. Investing in different asset classes provides an investor with diversification, which is an integral part of risk management.
How to Invest in Stocks and Bonds
With an Invest.MT5 account from Admirals, you can invest in over 4,300 shares from 15 of the world’s largest stock exchanges!
Furthermore, the Invest.MT5 account also allows you to invest in a variety of bond ETFs (Exchange-Traded Funds). Bond ETFs pool investor money in order to invest exclusively in bonds, meaning that with one investment, you can gain exposure to a range of bonds.
Follow these 4 steps to learn how to invest in stocks and bonds with Admirals:
- Register for an Invest.MT5 account and log in to the Dashboard
- Next to your account details, click ‘Invest’ to open the MetaTrader WebTrader
- Search for the instrument you want to invest in at the bottom of Market Watch on the left-hand side of the screen and drag it onto the chart
- At the top screen, select ‘New Order’, enter your order size and click ‘Buy’ to send the order to the market
Why Invest in Stocks and Bonds with Admirals?
Besides being able to invest in a wide variety of stocks and ETFs, Invest.MT5 account holders also benefit from:
- The ability to open an account with a minimum deposit of just €1
- Competitive transaction fees and no account maintenance costs
- Regular market analysis, as well access to a wide range of educational articles at no additional cost!
In order to open an account today, click the banner below:
About Admirals
Admirals is a multi-award winning, globally regulated Forex and CFD broker, offering trading on over 8,000 financial instruments via the world's most popular trading platforms: MetaTrader 4 and MetaTrader 5. Start trading today!
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of, or recommendation for, any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.
