What Sets Stocks Apart from Bonds?

Today, there is a significant influx of individual investors in the stock market. Many of them are absolute beginners who are not familiar with even the most basic terminology. Nevertheless, they all believe they can invest their funds profitably by buying stocks and/or bonds. However, there is little in common between these two investment assets. Before purchasing them, you need to find answers to several questions. What sets stocks apart from bonds? What is more profitable for beginners to invest in? In which cases should preference be given to which securities?

A Brief Overview of Stocks and Bonds

First and foremost, you need to understand what both of these securities represent. This determines the fundamental differences between stocks and bonds.

Stocks are equity securities. The name itself indicates that the owner (holder, shareholder) has a stake in the company’s ownership. They also have the right to participate directly in business management, which is expressed through voting at General Meetings when making key decisions. Shareholders are entitled to a portion of the company’s profits proportional to the size of the shareholding (dividend payouts).

Note! Stocks are divided into common and preferred. Common stocks grant voting rights and the possibility to receive dividends, subject to the decision of the General Meeting. Dividends on preferred stocks are paid out at a fixed rate if the company generates profits. However, holders of such securities do not typically vote on most issues.

Bonds are debt securities. They confirm that the investor (holder or bondholder) has provided the issuer with a loan from their own funds. In return, they are guaranteed the repayment of the loan amount on a certain date, as well as interest payments. Bond issuers can be governments (through authorized bodies, for example, in the US, the Treasury), municipal authorities, or companies. These securities have no relation to ownership, profit distribution, or company management.

The fundamental differences between these securities also determine their different properties. Market participants must take these into account when selecting investment instruments.

Stocks vs Bonds: Details

Let’s reiterate what you need to remember: shareholders are co-owners of the company, while bondholders are its creditors. Accordingly, their investment goals may vary, as well as the ability of securities to achieve them. You need to consider investing in stocks and bonds from this perspective. Based on this, let’s discuss the differences between these securities.

Periodic Payments

Security holders periodically receive payments as stipulated in the issuance documents. For stocks, holders receive dividends, the total amount and size of which are determined by the decision of the General Meeting.

There are no other periodic payments for shareholders. It should be noted that dividends represent a portion of the company’s profits, and whether or not to pay them is decided by the shareholders’ meeting. Dividend payments are the issuer’s right, not an obligation, so they may not occur.

Bondholders receive interest income at intervals specified in the bond issuance document. Additionally, upon maturity of the bonds, the final coupon is paid along with the face value. There are no additional payments for bonds, either. Unlike stocks, coupon payments on bonds are mandatory. If the issuer ignores them, it leads to a default situation.

Regularity of Payments

The timing and regularity of payments for stocks and bonds differ and are determined for each security.

Dividend payments for stocks usually occur once a year. Some companies pay dividends quarterly. The timing of dividend payments is set separately, and the decision is made by the General Meeting of Shareholders.

Again, if the company has no profits, or the General Meeting decides to reinvest all profits in business development or other needs, dividends will not be paid. There is an exception to this rule — holders of preferred shares receive dividends consistently if the company demonstrates profits by the reporting date. For them, skipping dividend payments is only possible if the issuer incurs losses for the reporting period.

Payments to bondholders occur regularly on a periodic basis — monthly, quarterly, semi-annually, and annually (depending on the frequency specified in the issuance documents). The frequency of payments remains unchanged throughout the term of the bond issue. Coupon payments cannot be missed, otherwise, the company will default.

Payment Size

The size of the income paid per share is determined according to the frequency specified in the issuer’s documents and by the general meeting of shareholders. Its magnitude depends on the company’s financial performance and can vary significantly over different periods. In case of unsatisfactory financial results, dividends may not be paid, meaning that the dividend yield of the investment can, in some cases, be zero.

The interest income paid to bondholders is regulated (and guaranteed) by the issuance documents. The yield and its modification procedure, if any, are clearly fixed in the bond issuance documents. Zero coupon payments are not allowed!

Market Value of Securities

Both stocks and bonds have a nominal value set by the issuance documents. During the initial offering, securities are usually bought and sold at their nominal value (or at some percentage above or below it). In the secondary market, the market value of securities can significantly differ from the nominal value.

The market value of stocks depends on the issuer’s financial performance, the level of dividends paid per share, and expectations of future financial results. The better the financial indicators and expectations, the higher the stock price. The price of stocks, and consequently equity, reflects the company’s performance and can both increase and decrease.

The price of a bond is directly related to its nominal value, the nominal yield to maturity, the term, and significantly depends on the overall interest rate in the economy. When the value of funds in the economy increases (interest rates raised by the central bank), bond prices, regardless of the issuer’s financial results, decrease, and vice versa, increase when the rate decreases. The change in market price can be significant but does not affect the nominal value, nominal yield, or repayment.

Guarantees and Risks

Like all investments, investments in securities carry risks for the investor.

Stocks are a more risky financial instrument. Shareholders are not guaranteed a return of their invested capital or any per-share payments. Even in the event of the issuer’s company’s liquidation, shareholders can expect only a portion of the assets remaining after paying off all debts, including those owed to bondholders.

Bonds are secured by the assets of the issuer’s company or other collateral and guarantee the repayment of the face value and regular interest payments. Bondholders receive funds before shareholders in the event of company liquidation. However, even they are not guaranteed a full return on their investments.

Term of Circulation

Stock is a perpetual security, meaning it exists until the dissolution of the corporation. Bonds are issued for a term specified in the issuance documents. There are “ultra-long” bonds with a maturity period of 30 years or more. However, their maturity dates are known in advance, unlike stocks.

Yield

The yield on investments in stocks or bonds also varies. This indicator often becomes decisive for investors when choosing specific assets.

For market participants, the yield on equity investments is often determined not only by dividend payments, or these are not even taken into account. Indeed, there are many companies in the market that do not pay dividends at all but demonstrate phenomenal financial results and stock price growth of hundreds of percent. Even for dividend aristocrats, situations where speculative returns (due to stock price growth) exceed dividend returns are more of a rule than an exception.

Thus, the yield obtained from stocks can be very high. This is especially true for growth stocks or high-yield stocks of lesser-known issuers.

The yield on debt investments is largely tied to the prevailing key rate and generally slightly exceeds the current inflation rate. This is especially true for fixed-income securities issued by high-credit-rating issuers, as well as treasuries.

However, stocks are considered a much riskier investment instrument than bonds. Accordingly, when forming portfolios, they are recommended to be included in the income portion, while bonds are typically used as defensive assets.

Note! Among stocks, there are also defensive instruments, such as dividend aristocrat stocks or perennial stocks. Among bonds, high-yield assets can also be found, such as junk bonds. But with changes in yield comes a price to be paid in terms of risk — the higher the first, the greater the second.

In general, stocks and bonds are completely different groups of investment instruments. Due to their different properties, they serve different functions in investment strategies. As an investor, you need to carefully study these differences and effectively use these securities when forming your own portfolio.