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Stocks vs. Bonds

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Stocks and bonds are two common asset types that investors use to create a balanced portfolio toward financial goals like building wealth or protecting capital. 

Both stocks and bonds offer the potential to provide returns and they both carry risks, but they have some key differences to understand as you choose investments. The main difference is that a bond is a form of debt – essentially a loan to a corporation or a government – while a stock is an ownership stake in a company. Bonds are considered lower risk than stocks, however stocks have the potential to offer more significant gains. 

What Are Bonds? 

Bonds are debt securities sold by corporations or governments to raise money for a variety of reasons, from providing cash flow to funding public projects like a schools or roads. 

When you buy a bond, you are essentially lending your money, which is repaid to you through regular fixed payments over a set term. Bonds are generally considered low risk assets, and investors use them to generate predictable income streams and to preserve their capital. 

Bonds can be classified as either investment grade or non-investment grade (“junk” bonds) based on their credit rating with a major credit agency like Moody’s, Standard & Poor’s, or Fitch. Investment grade bonds are lower risk, and they tend to provide lower returns. Non-investment grade bonds are higher risk, but generally offer higher returns. 

Investors have a range of bond types to choose from including: 

  • Corporate bonds issued from a company 
  • Municipal bonds issued by states, cities, counties, or other governments 
  • U.S. Treasuries issued by the federal government 

How Bonds Work 

When you buy a bond, you are essentially lending your money to a corporation or a government that is raising money for any number of reasons. The bond will have a price or “face value,” an interest rate, and a set term, which is the number of years you will receive payments. The end of the term is called the maturity date. 

The issuer will make regular payments to you, typically twice a year, until the bond is fully repaid with interest. By the maturity date, you will have your original investment amount returned with profit. 

A bond can increase or decrease in value depending on broader interest rate conditions. So, if you sell a bond before its maturity date, you may see losses or gains. Finally, some bonds may offer tax advantages, such as an income tax exemption on the interest. 

What Are Stocks 

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.1  

Shareholders often benefit if the company performs well as the market price of the stock increases amid higher demand. Similarly, if the company performs poorly, the stock can lose value. Investors typically buy stocks to achieve capital appreciation if the stock price increases, but they can also buy stocks to receive dividend payments or to participate in voting on company issues. 

The two main types of stocks are common stock and preferred stock. Common stock provides shareholders with voting rights and dividends if the company offers them. Preferred stockholders do not have voting rights, but they have priority over common stockholders for receiving dividend payments. And, if the company is ever liquidated because of bankruptcy, preferred shareholders are prioritized. 

Stocks can be categorized in many other ways, such as 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. Larger companies are generally less risky but smaller company offer the potential for higher returns.2 

Other categories of stock include: 

  • 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 that make them a bargain compared to their peers with higher PE ratios. 
  • Growth stocks: Investors buy growth stocks with the goal of building capital as these companies have earnings that tend to grow faster than the market average. 

How Stocks Work 

You can buy shares of a company through online brokers, many of which offer no-fee trades. After you fund the account, you can usually purchase assets within a matter of minutes. You can also use full-service brokers, which often charge fees for trades. Finally, some companies allow you to purchase stock directly from them, although you may still face fees. 

Are Bonds Safer Than Stocks? 

Bonds are considered a safer asset than stocks but, like with any investment, they do carry risks. 

One risk 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 the bond, or retire it before its maturity date, to issue new bonds and save money.3 

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. There is no guarantee that a stock will provide profit at all. 

The Bottom Line 

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 will depend 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 money. 

Consider consulting a professional financial advisor to help you understand the investment choices that may be right for you. 

Have Questions About Investing? 

Talk to a qualified financial advisor today to get professional advice today. Need help finding a financial advisor in your area? Give us a call today so we can match you with an advisor who will put your needs first.  

 

1 Investor.gov, “What are stocks?” https://www.investor.gov/introduction-investing/investing-basics/investment-products/stocks  

2 FINRA.org, “Market Cap, Explained” April 26, 2018.https://www.finra.org/investors/insights/market-cap  

3 Investor.gov, “What are bonds?” https://www.investor.gov/introduction-investing/investing-basics/investment-products/bonds-or-fixed-income-products/bonds  

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