Bond Market vs. Stock Market: An Overview
It's time to invest your money. So how exactly are you going to allocate that money? After all, a well-diversified portfolio strategy is recommended before you start to buy assets such as stocks and bonds. Indeed, stocks and bonds are two of the most traded types of assets—each available for sale on several different platforms or through a variety of markets or brokers. Here, we go over the primary differences between stocks and bonds.
- A stock market is a place where investors go to trade equity securities (i.e. shares) issued by corporations.
- The bond market is where investors go to buy and sell debt securities issued by corporations or governments.
- Stocks typically trade on various exchanges, while bonds are mainly sold over the counter rather than in a centralized location.
- In the United States, the prominent stock exchanges include Nasdaq and the New York Stock Exchange (NYSE).
What Is The Difference Between The Bond Market And The Stock Market?
The Bond Market
The bond market is where investors go to trade (buy and sell) debt securities, prominently bonds, which may be issued by corporations or governments. It is also known as the debt or the credit market. Securities sold on the bond market are all various forms of debt. By buying a bond, credit, or debt security, you are lending money for a set period and charging interest—the same way a bank does to its debtors.
The bond market provides investors with a steady, albeit nominal, source of regular income. In some cases, such as Treasury bonds issued by the federal government, investors receive bi-annual interest payments. Many investors choose to hold bonds in their portfolios as a way to save for retirement, for their children's education, or other long-term needs.
Investors have a wide range of research and analysis tools to get more information on bonds. Investopedia is one source, breaking down the basics of the market and the different types of securities available. Other resources include Yahoo! Finance's Bond Center and Morningstar. They provide up-to-date data, news, analysis, and research. Investors can also get more specific details about bond offerings through their brokerage accounts.
A mortgage bond is a type of security backed by pooled mortgages, paying interest to the holder monthly, quarterly, or semi-annually.
Where Bonds are Traded
The bond market does not have a centralized location to trade, meaning bonds mainly sell over the counter (OTC). As such, individual investors do not typically participate in the bond market. Those who do, include large institutional investors like pension funds foundations, and endowments, as well as investment banks, hedge funds, and asset management firms. Individual investors who wish to invest in bonds do so through a bond fund managed by an asset manager.
New securities are put up for sale on the primary market, and any subsequent trading takes place on the secondary market, where investors buy and sell securities they already own. These fixed-income securities range from bonds to bills to notes. By providing these securities on the bond market, issuers can get the funding they need for projects or other expenses needed.
For investors without access directly to bond markets, you can still get access to bonds through bond-focused mutual funds and ETFs.
Who Takes Part in the Bond Market?
The three main groups involved in the bond market include:
- Issuers: These are the entities that develop, register, and sell instruments on the bond market, whether they're corporations or different levels of government. For example, the U.S. Treasury issues Treasury bonds, which are long-term securities that provide bi-annual interest payments for investors and mature after 10 years. Investing in certain sectors of the bond market, such as U.S. Treasury securities, is said to be less risky than investing in stock markets, which are prone to greater volatility.
- Underwriters: Underwriters usually evaluate risks in the financial world. In the bond market, an underwriter buys securities from the issuers and resells them for a profit.
- Participants: These entities buy and sell bonds and other related securities. By buying bonds, the participant issues a loan for the length of the security and receives interest in return. Once it matures, the face value of the bond is paid back to the participant.
Bonds are normally given an investment grade by a bond rating agency like Standard & Poor's and Moody's. This rating—expressed through a letter grade—tells investors how much risk a bond has of defaulting. A bond with a "AAA" or "A" rating is high-quality, while an "A"- or "BBB"-rated bond is medium risk. Bonds with a BB rating or lower are considered to be high-risk.
The Stock Market
A stock market is a place where investors go to trade equity securities such as common stocks and derivatives including options and futures. Stocks are traded on stock exchanges. Buying equity securities, or stocks, means you are buying a very small ownership stake in a company. While bondholders lend money with interest, equity holders purchase small stakes in companies on the belief that the company performs well and the value of the shares purchased will increase.
The primary function of the stock market is to bring buyers and sellers together into a fair, regulated, and controlled environment where they can execute their trades. This gives those involved the confidence that trading is done with transparency, and that pricing is fair and honest. This regulation not only helps investors, but also the corporations whose securities are being traded. The economy thrives when the stock market maintains its robustness and overall health.
Just like the bond market, there are two components to the stock market. The primary market is reserved for first-run equities so initial public offerings (IPOs) will be issued on this market. This market is facilitated by underwriters, who set the initial price for securities. Equities are then opened up on the secondary market, which is where the most trading activity takes place.
The number of securities that first started trading on the New York Stock Exchange on May 17, 1792—the first day of trading.
The Prominent U.S. Stock Exchanges
In the United States, the prominent stock exchanges include:
- Nasdaq, a global, electronic exchange which lists the securities of smaller capitalization companies from different parts of the world. Although technology and financial stock make up the bulk of the index, it also includes consumer goods and services, healthcare, and utilities. This exchange also forms the basis of the U.S. technology sector benchmark index.
- New York Stock Exchange (NYSE) is the largest exchange in the world based on the total market cap of its listed securities. Most of the oldest and largest publicly-traded companies are listed on the NYSE. The NYSE has gone through a series of mergers and was most recently purchased by the Intercontinental Exchange (ICE) in 2013. Thirty of the largest companies on the NYSE make up the Dow Jones Industrial Average (DJIA), which is one of the oldest and most-watched indexes in the world.
- American Stock Exchange (AMEX), which was acquired by the NYSE Euronext and became the NYSE Amex Equities in 2009. It was first known for trading and introducing new products and asset classes. The exchange was also the first to introduce an ETF. Operating electronically, the exchange is home to mostly small cap stocks.
These markets are regulated by the U.S. Securities and Exchange Commission (SEC).
One major difference between the bond and stock markets is that the stock market has central places or exchanges where stocks are bought and sold.
The other key difference between the stock and bond market is the risk involved in investing in each. When it comes to stocks, investors may be exposed to risks such as country or geopolitical risk (based on where a company does business or is based), currency risk, liquidity risk, or even interest rate risks, which can affect a company's debt, the cash it has on hand, and its bottom line.
Bonds, on the other hand, are more susceptible to risks such as inflation and interest rates. When interest rates rise, bond prices tend to fall. If interest rates are high and you need to sell your bond before it matures, you may end up getting less than the purchase price. If you buy a bond from a company that isn't financially sound, you're opening yourself up to credit risk. In a case like this, the bond issuer isn't able to make the interest payments, leaving itself open to default.
Stock market performance can broadly be gauged using indexes such as the S&P 500 or Dow Jones Industrial Average. Similarly, bond indices like the Barclays Capital Aggregate Bond Index can help investors track the performance of bond portfolios.