Bonds vs stocks

The bond market and the stock market contain an endless number of popular instruments to invest in, and they are two of the largest financial markets in the world after forex trading.

You can trade on over 7750 shares and exchange-traded funds on our Next Generation trading platform through derivative spread bets and CFDs, and over 30 government bonds and interest-rate instruments through bond trading. Both markets cover a variety of sectors within finance, technology and healthcare, among many others.

When deciding on a market to get involved in, traders may ask themselves: is it better to invest in stocks or bonds? The truth is that it depends on each individual trader, their personality type, trading strategy and objectives. This article explores both differences and similarities, as well as the relationship between stocks and bonds and how they can correlate with or against each other in the financial markets.

The basics of stocks and bonds

Share trading is the process of buying and selling stocks within the share market with the aim of making a profit. This involves taking direct ownership of the asset. If you decide to purchase the instrument at spot price, then your ownership stake will be a percentage of how many shares you decide to invest in. On the other hand, when speculating on the price movements of shares with a spread betting or CFD trading account, you do not physically own the underlying asset but instead, you are essentially opening a position and placing a bet on whether you think the stock price will increase or decrease. Profits will depend if the markets move in your favour or not.

The treasuries market is made up of corporate, municipal and government bonds, also known as gilts in the UK. Bonds are fixed-income instruments that represent a long-term lending agreement between a borrower and a lender, often with the aim of financing external projects. The contracts are drawn up with a future maturity date, either short-term (up to 3 years), medium-term (around 10 years) or long-term (around 30 years). The borrower also promises to pay a fixed or variable interest rate, depending on what is agreed at the start of the contract. Read our article on ‘what are bonds?’ for more information about bond trading.

What are the differences between stocks and bonds?

Buying and selling stocks and bonds

Share trading usually takes place via an exchange, such as the London Stock Exchange (LSE). This exchange is regulated by the Financial Conduct Authority (FCA) and the terms and conditions cannot be changed once a position is opened.

On the other hand, bonds do not sell on an exchange but are rather over-the-counter products. This means that traders can negotiate directly with brokers in order to come to a deal, and either party can change terms and conditions at any point throughout the duration of the contract. For example, you can change the value of interest rates, delay payments and end the contract early, similar to a futures or forward contract.

Bond index vs stock index

You can choose whether to buy, sell or trade either singular shares or a collection of shares, which is known as a stock index. Stock market indices measure the performance and price behaviour of a section of shares, usually within a similar or of a similar market capitalisation. For example, the S&P 500 and Dow Jones Industrial Average indices track the performance of 30-50 large blue-chip stocks within the US stock market. This provides a benchmark for investors of the top performing companies that have stable balance sheets and cash flows, and they usually remain on the list for a long period of time.

A bond index measures the performance of a bond portfolio, which is often based on a specific sector of the bond market. For example, the S&P 500 Bond Index is a counterpart to the above mentioned stock index, used to measure the performance of US corporate debt that has been issued by components of the S&P 500. Bond indices are often market value-weighted and have specific characteristics that stock indices do not, such as maturity dates or credit ratings. This helps them to serve a more narrow section of the bond market. However, bond prices can often be more fluid than stock prices and therefore a bond index is harder to value than equities.

Bond market size vs stock market size

Although the treasuries market may appear to be less popular to traders than the stock market, there is an advantage of OTC trading. This allows investors to trade non-standard quantities of financial assets, which is particularly effective for block trades. A block trade should typically amount to at least $200,000 worth of bonds, meaning that the bond market is particularly appealing for institutional investors and international businesses that tend to carry out their trades at a high volume.

In fact, the bond market actually has a much higher market capitalisation than that of the stock market. As of December 2019, the market capitalisation for the worldwide bond markets has been valued at approximately $100 trillion, whereas the market capitalisation for worldwide stock markets values at approximately $70 trillion.

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Are bonds less volatile than stocks?

In general, bonds are usually seen as a less volatile investment than stocks. This is due to the stability of the bond market, and the fact that stock prices are constantly changing depending on external events, including economic and political factors. However, some sectors within the stock market have seen a steady increase in popularity and value over recent years, which makes companies more appealing for investors in the long-term. For example, pharmaceutical stocks and streaming stocks have proven successful in times of crisis, such as throughout the COVID-19 pandemic.

This also reflects the debate of bond returns vs stock returns. Although bond rates of return are generally lower than those of the stock market, there is more information available about their income flow and it is easier to predict bond performance and changes within the market. Therefore, you could say that they are a relatively safer investment. However, some traders thrive on the unknown and volatility within the stock market, therefore there is always the chance that taking a risk on share trading will pay off in the form of higher returns but could also lead to losses.

Read about some of the most popular bonds on our platform right now and how to get started trading on the bond market.

How are bonds and stocks similar?

Bonds and stocks are both derivative products, meaning that the contract’s value is reliant on the performance of an underlying asset or benchmark. Other examples of derivative products include forwards, futures and options, all of which can be used in the process of stock and bond trading.

Both instruments are sensitive to interest rates and preferred stock and bond prices tend to decrease when interest rates increase. This is because cash flows are discounted at a higher rate, resulting in a better yield, in particular within the stock market. Read or guide to the best dividend stocks in the UK.

Correlation between stocks and bonds

Within the financial markets, there is often correlation between a number of assets that have an effect on one another. In general, the assumption is that there is a positive correlation between the stock and bond markets. Therefore, when bond prices decline, stock prices will start to decline as well. This is because, if the cost of business rises due to inflation, then lenders will be less likely to issue bond contracts. This will then affect individual companies and their own share price will fall.

Periodically, the relationship between stocks and bonds has been proven to move in the opposite direction. Instead, bonds go up when stocks go down. This depends on the volatility of the markets, especially when inflation and growth of the equity market is low.

Often in these situations, traders decide to open positions for both stocks and bonds. An advanced trading strategy for cross-market assets is pairs trading, where you can open one long position and one short. However, there must be a positive correlation at the time of settling the contract for the strategy to work. The aim of pairs trading is to hedge risks in your trading portfolio by balancing positions that act as a hedge against each other. For stocks and bonds, you may be able to offset the risk of one declining long positon by opening another short position with an adverse correlation. Trading both equity and debt securities vastly increases the diversity of your trading portfolio, which means that the risk is also balanced between assets.

How to invest in stocks and bonds

Many investors choose to purchase stocks and bonds outright at spot prices, meaning that they will have a part ownership stake of the underlying asset. However, another method to get exposure to the stock and bond markets is through our derivative spread betting and CFD accounts. In particular, spread betting allows you to trade tax-free within the UK on the price movements of thousands of stocks, bonds and exchange-traded funds. Please note that tax treatment depends on individual circumstances and can change or may differ in a jurisdiction other than the UK.

If you have reached a conclusion about whether you would like to trade stocks, bonds or both markets simultaneously, then get started by registering an account with us.

Bond ETFs vs stock ETFs

You can also practise ETF trading through spread betting and CFDs, and trade on our most popular bond and share ETFs. These have varied liquidity, dividend payouts and other risk rates. We offer a wide range of exchange-traded funds, including those from iShares, Vanguard and SPDR.