Every investment in the market inherently has some amount of risk; thus it is always advised to diversify the investment portfolio to mitigate the risk (Un-Systematic Risk) specific to a particular company or specific to an asset class.
Investors are advised to own several types of financial instruments; the two most commonly used financial instruments are Bonds and Equity. Equity or shares represents the ownership or partnership in the business whereas bonds represents debt been given by the investor (bond holder) to the issuer of the bond.
Being two most commonly used investment vehicle; it’s important to understand the difference between bonds and equity.
Equity or Shares: Equity represent business owner’s the residual interest in the business once all the liabilities have been paid-off; thus equity can be describes as the net worth minus all the debts. Equity and shares are generally referred interchangeably but essentially equity represents the business owner ship whereas Shares are issued by companies to raise funds from the stock market.
Any investor can become partner in the company by buying the shares from the stock market; thus investment in the shares represents proportional ownership in the company, accordingly shareholders become partner both in gain and losses. Shareholders are entitled to proportional distribution of the profit in the form of dividend; when declared. Shareholders being partner in the business also have voting rights and with sufficient holding in the company could impact business decisions.
Bonds: Bonds also knows as Fixed Income security; represents the debt instrument created for the purpose of funding an ongoing project or a new project. Bonds are kind of financial contract wherein issuer of the bond (borrower of the money) agrees to pay investor (bond holder) a periodic interest payment and on the maturity of contract principal will be paid back to investor along with final interest payment. Periodic interest payments are known as coupon. Bonds are generally issued by government or big organizations to raise funds from the market.
Investment in shares or equity is like proportional ownership in the business; whereas investor in bonds acts as a creditor for the company. While investing in shares; being partner in the business expose investor to the risk inherent in the business; on the other hand bond holders does not partner in the losses and entitled to the fixed interest payment along with principal payback on the date of maturity.
Equity being risky investment gives the investor a chance to earn higher returns along with risk of losing money. Bonds on the other side are stable source of income for the investor with less (in comparison to equity) risk of loosing money until company or government go bankrupt and defaults on payment.
Equity (Shares) Vs Bonds final comparison:
|Proportional ownership in the company||Act as a lender|
|Voting rights.||No Voting rights.|
|Profit sharing in the form of dividend.||Interest Payment|
|Capital appreciation (Share Price Increase)||Capital appreciation if bonds are listed on stock market.|
|Riskier Investment||Stable or less risky Investment|
|Liquid in comparison to bonds||Less liquid than shares.|
|Common shares do not have expiry||Bonds have a maturity date|