Bonds vs Shares, What’s the Difference?
When it comes to investing, most people have heard of shares, stocks or equities. These investments, which are actually all just different words for the same financial instrument, give investors a small piece of ownership (equity/stock) in a company or corporation.
Bonds, debt securities and other fixed income investments, however, are all about loans/debt.
Instead of buying a share in the company, owners of debt securities and bonds generate income from the interest earned off the money they lend (in the form of securities or bonds) to the companies. The interest payments earned from these loans are known as “coupon payments.”
Why are the interest payments called coupon payments?
Financial jargon can be confusing, so if you’re wondering why bonds have coupon payments, rather than interest payments, here’s the story.
Before the digital revolution, a corporate bond (loan to a company) was a piece of paper. If the bondholder held the bond to the agreed date (the date where the company believed they would be able to repay the loan in full) they would be able to tear off a ‘coupons’ at regular intervals and get cash (interest) in return.
These intervals were usually 6, 12, 18 months and so on, and interest was paid until it reached the maturity date. Then, the investor (creditor) would hand back the bond (piece of paper) to the company in return for the initial loan amount.
Are shares riskier than bonds?
Shares are generally a higher risk investment, as the stock market is highly volatile, and heavily influenced by economic conditions, geopolitical issues, industry trends and statistical data.
Factors influencing the price of shares include interest rates, exchange rates, government policies, overseas financial markets and perceptions about how particular shares, or the market, will perform (this is called “investor sentiment”).
This is why the ASX200 can drop immediately after ABS data is released. It’s also why in the graph below, sourced from Vanguard’s Asset Tool, Australian shares saw both exceptionally high losses and returns in the twenty years to 2022.
Comparing the risks: Corporate Bonds & Fixed Income Securities vs. Shares (Stocks/Equities)
Equity investors (shareholders) can be paid dividends by the company they have bought shares in; however, this is not always the case. Fixed income investors on the other hand can generate predictable income from regular coupon payments.
As share values are generally tied to the financial and economic markets, there is also a greater risk of capital loss associated with shares when major economic events cause share prices to drop. Before investing in shares, bonds or other securities, make sure to seek the advice of a financial adviser, as insolvency law is complex and dependent upon different factors that can impact the outcome in a credit default or insolvency event.
CORPORATE BONDS &
FIXED INCOME SECURITIES
There is always risk of default or a credit event.
There is always risk of default or insolvency.
If interest rates rise, corporate bondholders can miss out on opportunities to earn higher coupon rates. If not held to maturity (and you choose to sell) changing interest rates can determine whether you make or lose money when you sell the bond.
When interest rates are high, stock markets generally decline in value. When interest rates are low, they typically increase in value. However, as all interest rate changes impact investor sentiment, there is no guarantee on how share markets will react to changing interest rates or how this will influence share prices.
Bond prices and coupon rates are influenced by economic and market factors. However, if you buy the bond and hold it to the maturity date, the agreed coupon rate and principal value remain the same.
As shares are part ownership in a company, the value of the share is tied to the financial market and is highly volatile. The value of a share is influenced easily by investor sentiment and there is no agreed rate of return.
*This list is not intended to be exhaustive, nor comprehensive. Various other risks apply depending on the investment made and various other factors. Before investing you should ensure you fully understand the risks associated with the investment and speak to a qualified financial adviser.
Do bonds earn more than stocks?
Generally speaking, bonds and other fixed income securities do provide a lower return on capital, however they do not carry the volatility risks that shares do. When you invest in shares, the value of your investments could double in one day, or they could halve.
This means your investment is always at risk, with no agreed financial return.
Fixed income investments have set maturity dates (loan terms) and a set principal value. This type of debt security positions you as the creditor, rather than a part owner, which places you higher in the creditor hierarchy.
Corporate bonds provide regular income payments to bondholders (creditors) based on a fixed interest rate (known as a coupon rate) and agree (subject to any credit events) to return the principal value at the maturity date.
Seen as “defensive assets” by many portfolio managers, these lower-risk, lower-return fixed income bonds and debt securities allow investors to avoid the higher risks associated with shares.
The predictable return structures mean that investors don’t have to worry about checking markets constantly and can “hedge their bets” in uncertain economic times to provide some confidence in the returns.
If you’d like to learn more about how to start investing in these securities from as little as $10,000 investment, book in your free strategy session here.
Disclaimer: The information and any advice provided in this newsletter has been prepared without considering your objectives, financial situation or needs. Because of that, you should, before acting on the advice, consider the appropriateness of the advice, having regard to those things.