Whether you’re investing for the first time or looking to fine-tune your existing portfolio, understanding stocks and bonds can help you build a solid financial foundation. Knowing how each works—and how to balance them—can help you invest with more confidence and align your strategy with your financial goals.
Key Takeaways
- Stocks provide ownership in a company.
- Bonds are generally considered lower risk than stocks.
- A balanced portfolio includes a mix of both.
- Stocks and bonds can help grow wealth.
What Are Stocks and Bonds?
Stocks and bonds are two of the most common ways to invest, whether you’re looking to grow your wealth or protect your savings. While both can help you reach your financial goals, they work in different ways and come with different risks. Understanding those differences can help you make smarter investment choices and maximize the growth of your portfolio. Here’s everything we believe you should know about stocks vs. bonds.
What Is a Stock?
Stocks, or equities, are securities that give investors a share of ownership in a company. Companies may issue stocks for any number of reasons, such as to pay off debt, launch new products, or expand their facilities. The payoff for shareholders comes if the company performs well, driving up the market price of the stock amid higher demand.
If the company performs poorly, however, the stock loses value. Investors typically buy stocks hoping for capital appreciation, when the stock price goes up. But some also invest to receive dividend payments or to have voting rights on company decisions.
Common and Preferred Stocks
Common stocks give shareholders voting rights and may offer dividends if the company chooses to distribute them. Preferred stocks don’t come with voting rights, but preferred stockholders do take priority over common stockholders when it comes to dividend payments. And, if a company liquidates as a result of bankruptcy, preferred shareholders have a higher claim on the company’s remaining assets.
Other Stock Categories
You can also categorize stocks by the size of the company’s market capitalization. Large-cap stocks are the largest, followed by mid-cap stocks, and then small-cap stocks. Investing in larger companies is generally less risky, but smaller companies offer the potential for higher returns.
- Income stocks: Investors buy income stocks for their predictable income. These stocks pay regular dividends.
- Value stocks: These companies have lower price-to-earnings (PE) ratios, which make them bargains compared to their peers with higher PE ratios.
- Growth stocks: Investors buy growth stocks to build capital, as these companies’ earnings tend to grow faster than the market average.
What Is a Bond?
Bonds are debt securities sold by governments or corporations to raise money, whether for building schools, funding operations, or expanding a business. When you buy a bond, you’re essentially lending money to a corporation or the government. The bond has a price or “face value,” along with an interest rate and a set term, i.e., the number of years you’ll receive payments. The end of the term is the maturity date.
The bond issuer makes regular payments to you—typically twice a year—until they’ve fully repaid the bond with interest. By the maturity date, you may have your original investment amount returned with profit. Keep in mind, however, that a bond can increase or decrease in value depending on broader interest rate conditions. And, if you end up selling the bond before its maturity date, you may see losses.
Certain bonds also may offer tax advantages, such as an income tax exemption on the interest. Let’s say you purchase municipal bonds issued by a local government to fund a road project. The interest earned on most of those municipal bonds will exempt you from federal income tax. You also may be exempt from state and local taxes on that bond if you live in the same state where the bond was issued.
Are Bonds Riskier Than Stocks?
Investors generally consider bonds to be lower-risk assets than stocks and use them to generate predictable income streams and to preserve their capital. They aren’t, however, risk-free, as interest rate changes or issuer defaults can impact returns.
Major credit agencies like Moody’s, Standard & Poor’s, or Fitch classify bonds as either investment grade or non-investment grade (“junk” bonds) based on their credit rating. Investment-grade bonds are lower risk, and they tend to provide lower returns. Non-investment grade bonds generally offer higher returns but come with greater risk.
Other Types of Bonds
As an investor, you can choose from a range of bond types, including:
- Corporate bonds issued by a company
- Municipal bonds issued by states, cities, counties, or other governments
- S. Treasuries issued by the federal government
Key Differences Between Stocks and Bonds
Wondering how bonds and stocks are different? Both help grow wealth, but each functions very differently, and choosing the right mix of both depends on your goals, risk tolerance, and investment timeline.
Ownership vs. Lending
Bonds are a form of debt where you lend money to a corporation or government in exchange for periodic interest payments and the return of principal at maturity. Stocks, on the other hand, give you ownership in a company, making you a shareholder with potential voting rights.
Risk and Return Profile
Like any investment, both carry risk. Investors consider bonds less volatile than stocks, while stocks have the potential to offer more significant gains.
Income Generation
While bonds may offer lower long-term growth, they can provide regular income through fixed interest payments. Stocks can generate income via regular dividends, but those are not guaranteed and can fluctuate.
Market Behavior and Volatility
Stocks tend to be more sensitive to economic conditions, corporate performance, and investor sentiment, leading to higher market volatility. While those with corporate bonds can still face credit risk, bonds—especially government bonds—usually have less volatility in general. Still, they aren’t necessarily immune to economic stressors, including tariffs, market liquidity, and interest rate changes. Investors’ best bets are to diversify assets with a mix of stocks, bonds, and alternative investments.
Are Bonds Safer Than Stocks?
One risk with bonds is that an issuer may default on the loan and fail to provide principal or interest payments. Or, if interest rates increase, the bond’s face value could decline, as buyers favor new bonds that pay more. Bondholders also face the risk that inflation rates could outpace the interest rates on their bonds, meaning they would lose money. Finally, bonds carry a risk that the issuer may call in the bond or retire it before its maturity date to issue new bonds and save money.
Stocks have more volatility than bonds. While investors have the potential to earn more over the long term with stocks, these assets can fluctuate up and down in the short term. If you’re looking at a longer-term financial horizon, stocks can be a good choice.
When Should You Invest in Stocks vs. Bonds?
You should invest in stocks when:
- You have a longer time horizon to let those stocks ride out market volatility.
- Your goal is capital appreciation for retirement or wealth building.
- You can tolerate some risk from market fluctuations.
- You’re concerned about inflation, as stocks historically outpace inflation better than bonds.
Building a Balanced Portfolio with Stocks and Bonds
Stocks and bonds each have unique advantages and downsides to keep in mind as you make investment choices. The right mix of stocks and bonds or other investment types depends on your personal financial situation and investing goals. Generally, younger investors with a longer time horizon may benefit from a more aggressive, stock-heavy portfolio to build wealth. Older investors in or near retirement may want to allocate more to bonds to protect their assets.
FAQs
Can I lose money investing in bonds?
Yes, you can lose money investing in bonds in a few ways:
- If interest rates rise
- If the issuer fails to repay its debt
- If inflation outpaces bond yields
Should I invest in stocks or bonds if I’m close to retirement?
If you’re nearing retirement, work with your financial advisor to create a mix of assets that includes stocks and bonds. For instance, bonds can help reduce the volatility of your portfolio and give you a stable income source. Stocks can help support long-term growth and combat inflation. Look at dividend stocks or short-term bonds for lower risk.
How do stocks and bonds perform in a recession?
The general rule of thumb is that stocks and bonds perform inversely because they respond differently to investor sentiment. When stocks drop, bonds rise—and vice versa. With their market volatility, stocks usually drop sharply early in a recession, but they recover as the economy improves. Bonds, particularly government bonds, often rise in value as investors seek safety. Keep in mind that corporate bonds may fall if default risks increase.
Can I invest in both stocks and bonds at the same time?
Yes, you can (and should) invest in both to balance your growth and income, diversify your risk, and to continue adjusting to your financial goals.
What is a 60/40 portfolio?
A 60/40 portfolio is a good balance for investors, with a mix of 60% stocks to 40% bonds. The 60% helps maximize growth of your portfolio, while the 40% in bonds can help with stability and income. Some investors are also now adding in alternatives such as real estate and gold for more diversification. Your portfolio mix should reflect your financial goals and risk tolerance, however.
Work With an Advisor to Find Your Ideal Mix
The right balance between investing in stocks vs. bonds depends on your unique financial situation—your goals, risk tolerance, and timeline. An advisor can help you assess your risk tolerance, align your investment goals, and adjust your plans over time. Ready for personalized investment advice? Match with an advisor today.
The views stated in this article are not necessarily the opinion of Cetera Wealth Services LLC, or CWM, LLC. and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results. All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful.
The return and principal value of bonds fluctuate with changes in market conditions. If bonds are not held to maturity, they may be worth more or less than their original value.
A diversified portfolio does not ensure a profit or protect against loss in a declining market.
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