Bonds vs Equities: Making the Right Investment Choice for Indian Investors 

When deciding where to invest, investors often weigh the options between bonds and equities. Both asset classes offer distinct advantages and risks, and understanding their differences can help investors tailor their portfolios to meet their financial goals. This blog will compare bonds and equities, focusing on their characteristics, benefits, risks, and taxation, to guide you in making a well-informed investment decision. 

Q: What are bonds and equities? 

A: 

• Bonds: Bonds are debt securities issued by corporations, municipalities, or governments to raise capital. Investors who buy bonds are lending money to the issuer in exchange for periodic interest payments and the return of the principal amount at maturity. 

• Equities: Equities represent ownership in a company. When you purchase shares of stock, you become a partial owner of the company and are entitled to a share of its profits, typically paid out as dividends, as well as potential capital gains if the stock price increases. 

Q: How do bonds and equities work in India? 

A: 

• Bonds: In India, bonds can be issued by the government, corporations, or municipal bodies. Investors receive regular interest payments (coupons) throughout the bond’s tenure. At maturity, the issuer returns the principal amount. Bonds can also be traded on secondary markets at profit or loss before maturity. Liquidity Risk which is defined as ability of the owner to sell the security before maturity is high for bonds compared to equities. 

• Equities: In India, equities are traded on stock exchanges such as NSE (National Stock Exchange) and BSE (Bombay Stock Exchange). Investors can buy and sell shares of companies through brokers. Returns come from dividends and capital appreciation, depending on the company’s performance and market conditions. 

Q: What are the types of bonds and equities available in India? 

A: 

Types of Bonds: 

1. Government Bonds: Issued by the central or state governments, these are low-risk securities that come with sovereign guarantee. Examples include Sovereign Gold Bonds, Treasury Bills, Government Securities (G-Secs), Government Savings Bonds, State Bonds, etc. 

2. Corporate Bonds: Issued by corporations to raise capital, these bonds generally offer higher returns compared to government bonds but come with increased credit risk. Corporate bonds are typically rated by credit agencies such as CRISIL and ICRA. 

3. Municipal Bonds: Issued by local government bodies, these bonds are used to finance public infrastructure projects. They offer a moderate risk level and may provide tax benefits under certain conditions. 

4. Tax-Free Bonds: Issued by entities like Indian Railways Finance Corporation (IRFC), National Highways Authority of India (NHAI), and Power Finance Corporation (PFC), these bonds offer interest income that is exempt from income tax under Section 10(15) of the Income Tax Act. 

5. Fixed Maturity Plans (FMPs): These are closed-end mutual fund schemes that invest in fixed-income securities with a defined maturity period, often mimicking the characteristics of bonds. 

Types of Equities: 

1. Blue-Chip Stocks: Shares of large, established companies with a strong track record of stability and reliable performance. Examples include Reliance Industries, HUL, and Tata Consultancy Services (TCS). 

2. Mid-Cap and Small-Cap Stocks: Shares of companies with medium to small market capitalizations. Mid-cap stocks could offer a balance between growth and stability, while small-cap stocks can be more volatile and riskier but potentially have higher growth prospects. 

3. Dividend Stocks: Shares of companies that regularly distribute a portion of their profits to shareholders as dividends. These stocks provide a steady income stream in addition to potential capital appreciation. 

4. Equity Mutual Funds: Investment funds that pool money from multiple investors to invest in a diversified portfolio of stocks. These funds are managed by professionals and can include large-cap, mid-cap, small-cap, or sector-specific funds. 

5. Exchange-Traded Funds (ETFs): Funds traded on stock exchanges that track specific indices or sectors. ETFs offer liquidity and can include a broad range of equities or a specific market segment. 

Q: What are the benefits of investing in bonds and equities in India? 

A: 

• Benefits of Investing In Bonds: 

• Stable Returns: Bonds provide predictable income through regular interest payments. 

• Capital Preservation: The return of the principal amount at maturity ensures capital preservation. 

• Diversification: Bonds can add stability to a portfolio dominated by volatile equities. 

• Tax Benefits: Certain bonds offer tax-free interest income. 

• Benefits of Investing In Equities: 

• Capital Appreciation: Potential for significant capital gains if the stock price increases. 

• Dividends: Regular dividend payments provide income and can be reinvested. 

• Ownership: Equity investors have voted rights and a share in the company’s growth. 

• Liquidity: Shares can be easily bought and sold on stock exchanges 

• Tax Benefits: Lower capital gains taxation compared to taxation on interest income (as per investor tax slab) on bond investments. 

Q. What are the risks associated with bonds and equities in India? 

A. 

Risks associated with Bonds in india: 

1. Credit Risk: This is the risk that the issuer of the bond may default on its payments. Credit risk varies depending on the issuer. Government bonds typically have lower credit risk compared to corporate bonds. However, corporate bonds with lower credit ratings or those issued by companies in financial distress may have higher credit risk. 

2. Interest Rate Risk: Bond prices are inversely related to market interest rates. This means that when market interest rates rise, the prices of existing bonds generally fall. Conversely, when market interest rates decline, the prices of existing bonds may increase. The key interest rates influencing this include: 

• Central Bank Rates: Rates set by central banks, such as the Reserve Bank of India (RBI), such as the repo rate or reverse repo rate, influence overall market interest rates. 

• Government Bond Yields: The yields on government securities (G-Secs) serve as benchmarks for other interest rates. An increase in government bond yields often leads to higher market interest rates, affecting bond prices. 

• Short-Term and Long-Term Rates: Changes in the interest rates for various maturities of financial instruments impact bond prices. For example, a rise in short-term rates can lead to higher rates for similar maturities, affecting bond prices. 

3. Inflation Risk: Inflation can erode the purchasing power of the interest payments, and the principal amount received upon maturity. Bonds with fixed interest rates may be adversely affected if inflation rates rise significantly, reducing the real value of the returns. 

4. Liquidity Risk: Some bonds may be less liquid than others, meaning they may be harder to sell quickly at a fair price in the secondary market. This can be particularly true for bonds with lower credit ratings or those issued by smaller companies. 

5. Reinvestment Risk: The risk that interest payments or the principal repayment may have to be reinvested at lower interest rates than initially anticipated. This risk is particularly relevant if bond interest rates decline during the bond’s holding period. 

Risks associated with Equities in India: 

1. Market Risk: Equities are subject to market risk, where the overall market conditions impact stock prices. Economic downturns, political instability, or changes in market sentiment can lead to significant fluctuations in stock prices. 

2. Company-Specific Risk: This risk is related to factors affecting a specific company, such as poor financial performance, management issues, regulatory changes, or competitive pressures. Company-specific risk can lead to stock price declines independent of broader market movements. 

3. Volatility Risk: Equities can exhibit high levels of volatility, with stock prices experiencing large swings in value over short periods. This volatility can be driven by company news, market trends, and economic data, and can affect short-term investment outcomes. 

4. Economic Risk: Broader economic factors, such as inflation, interest rate changes, or economic recessions, can impact the performance of equities. Economic slowdowns can lead to lower corporate earnings and reduced stock prices. 

5. Liquidity Risk: While most blue-chip stocks are highly liquid and can be bought or sold quickly, some smaller or less widely traded stocks may be less liquid. This can result in difficulties in executing trades at desired prices, especially in large quantities. 

6. Regulatory Risk: Changes in laws, regulations, or government policies can affect business operations and profitability. For instance, new regulations impacting a particular sector can have a significant impact on the stock prices of companies within that sector. 

7. Currency Risk: For investors in international equities, fluctuations in currency exchange rates can impact returns. This risk is relevant for investments in foreign stocks where the value of the local currency can influence the overall investment return in the investor’s home currency. 

Q: How do bonds and equities compare in terms of returns in India? 

A: 

• Returns from Bonds: Typically provide lower but more stable returns compared to equities. Corporate bonds may offer higher returns than government bonds but come with increased risk but still relatively lower than equities. 

• Returns from Equities: Historically offer higher returns over the long term compared to bonds, but with higher volatility and risk. Equity returns come from capital appreciation and dividends. 

Q How can investors choose between bonds and equities in India? 

A: 

What to choose: Bonds or Equities 

• Risk Tolerance: Investors with a higher risk appetite may prefer equities for potential higher returns, while those seeking stability might choose bonds. 

• Investment Horizon: Bonds may be more suitable for conservative investors with a shorter to medium-term horizon, whereas equities are better for long-term investors willing to withstand market volatility. 

• Income Needs: Investors seeking regular income may favour bonds, while those looking for growth potential might opt for equities. 

• Tax Considerations: Investors should consider the tax implications of both asset classes and their own tax bracket when making investment decisions. 

• Diversification: For majority of the investors, balanced portfolio of equities and bonds serves well for good portfolio returns with allocations based on individual investor’s risk appetite – Higher risk appetite would mean higher allocation of equities and lower risk appetite would mean higher allocation of bonds. 

FAQs 

Q: Can NRIs invest in bonds and equities in India? 

A: Yes, NRIs can invest in both bonds and equities in India. They must comply with regulatory requirements and can do so through NRO or NRE accounts. 

Q: Are bonds and equities equally safe? 

A: Bonds overall as an asset class carry lower risk than equities. Government bonds are the safest relative to other investment securities. Equities carry higher risk due to market volatility and company-specific factors. 

Q: Can I sell bonds and equities before maturity? 

A: Yes, bonds can be sold on the secondary market before maturity if there is buyer. Liquidity risk for bonds is higher than equities. Equities can be more easliy bought and sold anytime on stock exchanges. 

Q: Do bonds and equities offer better returns? 

A: Equities generally offer higher potential returns if held for long periods (7+ years) compared to bonds, but with greater risk. Bonds offer stable returns but usually at lower rates than equities.