How Bonds Affect the Stock Market
There is fierce competition between bonds and the share market as both vie for the investor’s money.
Overall, bonds are a safer tool for investors than stocks. But they offer a lower return. So, the demand for bonds dips when stocks go up in the market.
Understanding bonds and stocks
Bonds are loans made to a government or corporation. Interest payments from a bond stay unchanged during its lifetime.
This is a guaranteed income. And you are bound to receive the principal—provided the corporation involved does not default. It is customary to compare a bond’s return, known as its ‘yield’, to returns from other bonds.
In contrast, stocks are a share of a company’s ownership. Only corporate profits determine their share price which changes every day.
This value is determined by the estimates of future earnings of the company involved with respect to other companies.
High demand for stocks emerges when the economy is doing well. This boosts the confidence of stock market investors.
They put their money on stocks and corporations earn big due to the spike in demand.
But a laggard economy puts a brake on the demand for stocks. Stock prices fall in the share market and investors choose to opt for the regular interest payments that are guaranteed by bonds.
In some instances, both stocks and bonds may rise in value. This typically happens when there is too much liquidity in the market.
This may also happen in case of excess money and limited investment options, typically at the top of the market.
This phase depends on the optimism of a large group of investors. There are also times when both shares and bonds fall in value.
This takes place when the economy is so poor that investors press the panic button and sell all their investments.
Shares and bonds—which one to choose?
This is a much-discussed question among investors. You must assess a few important points:
- Need for investment: You need to analyze why you are investing. If you need a steady and safe income, investing in a bond is a better idea.
- If your target is wealth creation, however, investing in stocks would suit you better.
- Risk profile: Bonds carry a lower risk than stocks and shares. If you have a low-risk appetite, it’s wise to invest in a bond.
- If you are willing to take more risk, the stock market investments would be ideal for you.
- Overall economic situation: You must consider the performance of the economy. If you see a booming economy, stocks will gain more value and fetch more benefits. But it’s better to opt for bonds to safeguard your investment and earn interest payments in a slow economy.
Your economic status: You can hold onto your stocks if you do not need any immediate returns from the investment.
In this way, you can outpace inflation. It is the preferred target for young people who have a steady and well-paying job.
However, you should go for bonds if you need to use your investment income and cannot afford to wait for your investment.
Mixed strategy
It is advisable to have a good mix of bonds and shares, depending on your risk appetite and requirements.
Such diversification will help you overcome any possible crisis. It may help to open an account with a reliable stockbroker like Kotak Securities that can provide the necessary guidance to ensure the best returns.
Tailpiece
Bonds and stocks are two competitive asset types that provide different types of returns.
Develop your investment philosophy based on a preferred time horizon. Diversify your portfolio accordingly and you will reach a win-win situation with your investments.
Category: Investing
