Stocks vs bonds: what is the difference?

Stocks and bonds are the two building blocks most investors start with. On the «Toshkent» Respublika fond birjasi (UZSE) you can find both: shares of Uzbek companies and bonds issued by companies and other borrowers. They are often mentioned together, but they work in very different ways. This guide explains what each one is, how you can earn money from it, what can go wrong, and how people use the two together.

What a stock is

A stock (a share, or aksiya in Uzbek) is a small piece of ownership in a company. If a company has issued one million shares and you own one thousand of them, you own one tenth of one percent of that business. As a shareholder you usually get a vote at the general meeting of shareholders and a claim on part of the company's profit.

You can earn money from a stock in two ways:

• Dividends. When a company makes a profit, its shareholders can decide to pay part of it out as dividends. Dividends are not promised: a company can reduce them, skip them or never pay them.
• Price growth. If the company grows and investors value it more highly, the market price of the share can rise. You only turn that gain into money when you sell.

Both can also go the other way. A company can have a bad year, the share price can fall below what you paid, and in the worst case a company can fail and its shares can lose most or all of their value. Shareholders are paid last: if a company is wound up, its lenders, including bondholders, have a claim before the owners.

Some companies also issue preferred shares. These usually have a priority right to a dividend set in the company's charter, but often fewer voting rights than ordinary (common) shares. The exact terms depend on the issuer, so read them before you buy.

What a bond is

A bond (obligatsiya) is a loan that you make to the issuer. The issuer might be a company, a bank or a government body. In return, the issuer promises to pay you interest, called the coupon, on a fixed schedule, and to repay the face value (the nominal amount) of the bond when it matures.

Here is a simple, hypothetical example. Suppose you buy a bond with a face value of 1,000,000 soʻm, a coupon rate of 10% a year and three years left to maturity. If everything goes to plan, you receive 100,000 soʻm of coupon each year (before any tax) and your 1,000,000 soʻm back at the end. These numbers are only an illustration, not a real bond.

Bonds are usually more predictable than stocks, but they are not risk-free:

• Credit risk. The issuer may be late with a payment or fail to pay at all. A bond is only as reliable as the borrower behind it.
• Interest rate risk. If interest rates in the economy rise after you buy, new bonds pay more, so the market price of your older bond tends to fall. If you need to sell before maturity, you may get less than you paid.
• Inflation risk. A fixed coupon buys less when prices rise quickly.
• Liquidity risk. Some bonds trade rarely, so finding a buyer at a fair price can take time.

For a closer look at coupons and yields, read bond yield, coupon and price.

Stocks vs bonds side by side

The easiest way to remember the difference is: with a stock you are an owner, with a bond you are a lender. That one fact explains most of the other differences.

• What you receive. A stock may pay dividends that change from year to year. A bond promises a coupon set in its terms.
• Upside. A stock has no ceiling on how much it can grow. A bond's best case is usually receiving all coupons and the face value back.
• Downside. A stock price can swing widely. A bond price usually moves less, although a bond can still lose value if the issuer gets into trouble.
• Time limit. A stock has no maturity date: you own it until you sell. A bond has a maturity date when the principal is due to be repaid.
• Priority. If the issuer fails, lenders are paid before shareholders.
• Control. Ordinary shares usually carry votes. Bonds do not.

None of this makes one better than the other. They do different jobs.

How investors use both

Because stocks and bonds react differently to the same events, many investors hold both. Stocks are the part of a portfolio that is expected to grow over long periods, with bigger ups and downs along the way. Bonds are the part that is expected to produce steadier income and soften the swings.

How much of each you hold depends on your own situation:

• Time horizon. Money you need in a year or two is usually not a good fit for stocks, because prices can be down just when you need to sell. Money you will not touch for many years can ride out more ups and downs.
• Tolerance for losses. Ask yourself honestly how you would feel if part of your investment fell by a third for a while. If you would sell in a panic, a calmer mix may suit you better.
• Income needs. If you want regular payments, coupons and dividends matter more than price growth.

A hypothetical example: an investor saving for a goal many years away might hold mostly stocks, while someone who needs the money soon might lean towards bonds and deposits. This is an illustration of the reasoning, not a recommended split. Spreading money across different assets and issuers is called diversification, explained in diversification and risk.

Before investing at all, it also helps to have an emergency fund in cash, so you are never forced to sell at a bad moment. See emergency fund and budgeting.

How to look at stocks and bonds on UZSE

You can explore both types of securities on Finmind without a Finmind account. The stocks page lists shares traded on UZSE, with a page for each ticker, and the UZSE bonds page lists exchange-traded bonds with a page for each bond. Company disclosures, such as annual reports and notices of dividend decisions, are published on openinfo.uz.

If you want to get a feel for price swings before you commit real money, you can create a free Finmind account and practise buying and selling UZSE shares with virtual money in the simulator, or work through the free tutorials. When you are ready to buy for real, the steps are explained in how to buy shares in Uzbekistan.

This article is for education only and is not investment advice. Investing in securities involves risk, including the loss of money you invest.