Stocks and bonds each possess their own sets of advantages and disadvantages. Furthermore, each asset class features dramatically different structures, payouts, returns, and risks. Understanding the distinguishing factors that separate these two asset classes is key to building a healthy investment portfolio that thrives over the long haul.
Of course, asset allocation mixes are unique to each individual, based on an investor's age, risk tolerance, and long-term investment and retirement goals.
Key Takeaways
- Stocks offer the potential for higher returns than bonds but also come with higher risks.
- Bonds generally offer fairly reliable returns and are better suited for risk-averse investors.
- For most investors, diversifying portfolios with a combination of stocks and bonds is the best path toward achieving risk-mitigated investment returns.
Buying Stocks Instead of Bonds: An Overview
Stocks are essentially ownership stakes in publicly-traded corporations that give investors an opportunity to participate in a company's growth. But these investments also carry the potential of declining in value, where they may even drop to zero. In either scenario, the profitability of the investment depends almost entirely on fluctuations in stock prices, which are fundamentally tied to the growth and profitability of the company.
A bond is a fixed income instrument that represents a loan made by investors (known as "creditors" or "debtholders") to borrowers, which are typically corporations or governmental entities. Also known as coupons, bonds are characterized by the fact that the ultimate payouts are guaranteed by the borrower. With these investments, there is a concrete maturity date, upon which the principal is repaid to investors, along with interest payments attached to the interest rate that existed at the onset of the loan.
Bonds are used by corporations, states, municipalities, and sovereign governments to finance a multitude of projects and operations. That said, some bonds do carry the risk of default, where it is indeed possible for an investor to lose their money. Such bonds are rated below investment grade, and are referred to as high-yield bonds, non-investment-grade bonds, speculative-grade bonds, or junk bonds. Nevertheless, they attract a subset of fixed income investors that enjoy the prospect of higher yields.
Pros of Buying Stocks Instead of Bonds
The chief advantage stocks have over bonds, is their ability to generate higher returns. Consequently, investors who are willing to take on greater risks in exchange for the potential to benefit from rising stock prices would be better off choosing stocks.
Investors may also wish to consider investing in dividend-paying stocks. A dividend is essentially a distribution of some of the profits that a corporation makes to its shareholders. And any dividends that are not taken may be re-invested in the businessin the form of more shares in a company.
Bonds also pay regular income in the form of interest payments; however, these cannot be reinvested back into the same bond. Interest rates can change over the life of the bond, which creates reinvestment risk, or the risk that new bonds will have lower yields than the ones you are receiving interest from.
Diversifying investments across both stocks and bonds, marries the relative safety of the bonds, with the higher return potential of stocks.
Cons of Buying Stocks Instead of Bonds
In general, stocks are riskier than bonds, simply due to the fact that they offer no guaranteed returns to the investor, unlike bonds, which offer fairly reliable returns through coupon payments. Stocks are inherently more volatile than bonds because in the event of a corporate bankruptcy, bondholders (who are a company's creditors) have priority in being repaid. Meanwhile, owners of common stock are last in line, and can end up with nothing if the company goes bankrupt.
Risk-averse investors looking to safely deploy their capital and take comfort in more structured payout schedules would be better off investing in bonds.
Have Stocks or Bonds Performed Better Historically?
The historical returns for stocks have been between 8%-10% since 1928. The historical returns for bonds have been lower, between 4%-6% since 1928. Over the past 30 years, stocks have returned an average of 11% annually; while bonds have returned just 5.6% per year, on average.
How Much of My Portfolio Should Be in Stocks?
A well-diversified portfolio contains a broad range of holdings across several asset classes. In general, the longer your time horizon (i.e., the younger you are), the more risk you can take on. Therefore a portfolio weighted 80-90% in stocks and the rest in bonds or other assets is bearable. However, as your time horizon shortens, it is recommended to shift your allocation increasingly toward lower-risk bonds and reduce your allocation to stocks.
Why Do Stocks Generally Outperform Bonds Over Time?
Stocks generally outperform bonds over time due to the equity risk premium that investors enjoy over bonds. This is an amount that investors of stocks demand in return for taking on the additional risk associated with stocks. Stocks also benefit from a growing economy. As GDP grows, so too do corporate profits, which are reflected in the prices of stocks, but not typically in bonds (which are essentially loans).
FAQs
Stocks offer the potential for higher returns than bonds but also come with higher risks. Bonds generally offer fairly reliable returns and are better suited for risk-averse investors.
Is it better to invest in stocks or bonds? ›
As you can see, each type of investment has its own potential rewards and risks. Stocks offer an opportunity for higher long-term returns compared with bonds but come with greater risk. Bonds are generally more stable than stocks but have provided lower long-term returns.
Should I switch from bonds to stocks? ›
Given the numerous reasons a company's business can decline, stocks are typically riskier than bonds. However, with that higher risk can come higher returns. The market's average annual return is about 10%, not accounting for inflation.
Why bonds are not a good investment? ›
The interest income earned from a Treasury bond can result in a lower rate of return versus other investments, such as equities that pay dividends. Dividends are cash payments paid to shareholders from corporations as a reward for investing in their stock.
What is the main disadvantage of owning stock? ›
Disadvantages of investing in stocks Stocks have some distinct disadvantages of which individual investors should be aware: Stock prices are risky and volatile. Prices can be erratic, rising and declining quickly, often in relation to companies' policies, which individual investors do not influence.
Will bonds outperform stocks in 2024? ›
Bond outlooks improve, but stocks' prospects drop on the heels of 2023′s rally. Better things lie ahead for bonds, but the prospects for stocks, especially U.S. equities, are less rosy.
Do stocks have higher returns than bonds? ›
Stocks have historically delivered higher returns than bonds because there is a greater risk that, if the company fails, all of the stockholders' investment will be lost (unlike bondholders who might recoup fully or partially the principal of their lending).
Why would someone choose bonds over stocks? ›
Stocks offer the potential for higher returns than bonds but also come with higher risks. Bonds generally offer fairly reliable returns and are better suited for risk-averse investors.
Should I buy bonds when interest rates are rising? ›
Should I only buy bonds when interest rates are high? There are advantages to purchasing bonds after interest rates have risen. Along with generating a larger income stream, such bonds may be subject to less interest rate risk, as there may be a reduced chance of rates moving significantly higher from current levels.
Do bonds do well in recession? ›
The short answer is bonds tend to be less volatile than stocks and often perform better during recessions than other financial assets. However, they also come with their own set of risks, including default risk and interest rate risk.
How to get the most value from your savings bonds
| Face Value | Purchase Amount | 30-Year Value (Purchased May 1990) |
|---|
| $50 Bond | $100 | $207.36 |
| $100 Bond | $200 | $414.72 |
| $500 Bond | $400 | $1,036.80 |
| $1,000 Bond | $800 | $2,073.60 |
May 7, 2024
Since 2011, Gallup has asked Americans to choose among real estate, stocks, gold, savings accounts and bonds as the best investment. Cryptocurrency was added as an option in 2022. Real estate has topped the list each year since 2014, with between 30% and 45% (in 2022) selecting it.
Why is it bad to buy bonds? ›
Some Bonds Can Be Called Early
It's a risk because you'll no longer have a reliable income stream from the bond. Often, this happens when interest rates fall. Although lower rates might increase your bond's value, the issuer isn't buying the bond from you—it's simply paying off the debt early.
When to move from stocks to bonds? ›
During a bear market environment, bonds are typically viewed as safe investments. That's because when stock prices fall, bond prices tend to rise. When a bear market goes hand in hand with a recession, it's typical to see bond prices increasing and yields falling just before the recession reaches its deepest point.
Why is investing in stocks so risky? ›
Stocks are much more variable (or volatile) because they depend on the performance of the company. Thus, they are much riskier than bonds. When you buy a stock, it is hard to estimate what return you will receive over time (if any). Nonetheless, the greater the risk, the greater the return.
Why would an investor prefer purchasing bonds to purchasing stocks? ›
Stock prices are volatile and can fluctuate quickly based on market conditions, company performance, and other factors. On the other hand, bonds provide a predictable income stream and a fixed return on investment, making them a safer investment option.
Why would someone buy a bond instead of a stock? ›
Generally, yes, corporate bonds are safer than stocks. Corporate bonds offer a fixed rate of return, so an investor knows exactly how much their investment will return. Stocks, however, typically offer a better rate of return because they are riskier.
Is it easier to value a stock or bond? ›
Answer and Explanation:
As a result, establishing an accurate present value of the bond cash flows is fairly easy. Stocks, on the other hand, entail a high degree of uncertainty. The timing and amount of future earnings and dividend distributions are unknown.
Should you buy bonds when interest rates are high? ›
Should I only buy bonds when interest rates are high? There are advantages to purchasing bonds after interest rates have risen. Along with generating a larger income stream, such bonds may be subject to less interest rate risk, as there may be a reduced chance of rates moving significantly higher from current levels.
What is the average return on bonds? ›
The bond market is a wide field, with many different categories of assets. In general, you can expect a return of between 4% and 5% if you invest in this market, but it will range based on what you purchase and how long you hold those assets.
