Stocks vs. bonds: what’s the difference?

Summary 

• Stocks represent fractional ownership in a company, whereas bonds are more like a loan between you and a government entity or corporation. 
• Stocks typically offer higher returns and more volatility, while bonds are the safer investment with lower returns. 
• Stocks and bonds can both be a strategic part of your investment portfolio. 
• You can find a financial advisor through Unbiased, who can advise you on which investments you’ll want, how to allocate to each, and how they fit into a comprehensive financial plan.  

What are stocks?

Stocks offer ownership in a publicly traded company by investing in shares, or stock, of the company. You benefit when the company outperforms the market and realizes gains as its share price increases in value. You can trade stocks through many brokerages. 

Advantages of stocks

• Many opportunities for investing: There are many ways you can invest in stocks. From companies you believe in to dividend-paying stocks, there are a number of ways you can invest. 
• Higher returns: It’s possible to see higher returns and growth in your investment portfolio by investing in individual stocks. 
• Economic growth: Stocks can appreciate during periods of economic growth. 
• Highly liquid: Publicly traded companies are easy to buy and sell.

Disadvantages of stocks

• Limited market exposure: Owning individual stocks limits your exposure to the entire stock market, which may mean your portfolio is more volatile with more risk. 
• Personal research and time: You’ll need to be actively involved in researching and trading your stocks. 
• Taxes: Your stock trades may be subject to capital gains. There are strategies you can use to minimize taxes, but you’ll want to speak to a financial advisor who specializes in tax efficiency. 
• Market risk: Investing in individual stocks isn’t a surefire way to build your portfolio. The company may go under, and you’re not guaranteed a return. 

What are bonds?

Bonds are a low-risk investment that offer income to investors. When investors buy bonds, they lend money to a government entity or corporation and receive interest payments in return while holding the investment. 

Buying bonds helps diversify your portfolio. Bonds are considered a safe investment because they’re secured by governments that can tax their citizens to pay you. The trade-off is that you typically see lower returns than you would by investing in stocks.

Advantages of bonds:

• Fair yield: Bonds may offer a better yield than other investments, such as CDs. 
• Liquidity: Bonds are a fairly liquid investment that you can sell when you need to. 
• Different types of bonds to invest in: The wide variety of bonds available to invest in gives you options. You can look for bonds from the federal government, municipal bonds, investment-grade corporate bonds, mortgage-backed securities, treasury inflation-protected securities, agency bonds, high-yield corporate bonds, emerging market bonds, and more.
• Portfolio diversification: Bonds help diversify your portfolio.
• Tax-advantaged: Bonds can offer tax advantages. For example, there’s no federal tax on municipal bonds, and local tax savings on federal bonds. 

Disadvantages of bonds:

• Conservative earnings: The yield on bonds is very modest. Stocks typically outperform bonds over time.  
• Default risk: It’s possible that the issuer of the bond may be unable to pay investors. A credit-rating system is in place to help you evaluate risk from a bond issuer. 
• Interest rate risk: When interest rates rise, the value of a bond goes down. It’s a risk if you need to sell the bond before maturity on the secondary market. 
• Inflation risk: If inflation is high, the interest you’re paid won’t change, and your money will be worth less over time.  

How do stocks and bonds compare?

Stocks and bonds are very different investment types, but both fit into your financial plan. 

Here’s a summary of how the key characteristics of stocks and bonds compare. 

Trading

Both stocks and bonds are highly liquid investments. You’ll mainly see bond liquidity decline when the market is stressed and investors are looking to sell before the bond’s maturity date. 

Performance

Stocks have greater upside potential but also higher risk and volatility. Bonds offer the complete opposite – a guaranteed rate with no deviation, but with a much more conservative yield.

Risk

Stocks come with market risk, so they can lose value and frustrate investors. Bonds have less risk. Bonds can lose value, which is an issue if you need to sell them before maturity. You also take on more risk with bonds issued by governments and corporations with lower credit ratings. 

Tax

With either bonds or stocks, you should be looking to create a strong tax strategy. Especially for stocks, you’ll also want to take into consideration tax allocation with a financial advisor to ensure your investment is in the right account for optimal tax treatment. With bonds, there is some tax efficiency built in, as several bond types are tax-exempt. 

Diversification

It can be difficult to achieve a diversified portfolio when you trade individual stocks. However, adding individual stocks to a comprehensive portfolio could benefit you. Adding bonds to your portfolio can also help you achieve diversification. 

Capital preservation

Bonds are a more secure form of capital preservation. If you hold the bond until maturity, you’ll receive the full amount back, provided the issuer doesn’t default. With stocks, there’s no guarantee you’ll receive your investment back.

Income

Bonds are an investment known for providing income. Once you invest in a bond, you receive periodic interest payments (typically once every six months). Stocks often don’t pay income, as most companies elect to reinvest profits to grow their business. However, there are dividend-paying stocks that can provide income.

Type of ownership

With stocks, you own a part of the company. With bonds, you’re acting as a lender and don’t own shares of the company. 

Stocks vs. bonds: What is right for you?

Stocks and bonds are both essential components of a comprehensive financial plan. To best understand the part they play, consider the following:

• How do you want to invest? Stocks are individual investments in publicly traded companies. Bonds are loans to governments and corporations.  
• How close are you to retirement? If you’re close to retirement and want to invest in something that guarantees capital preservation while paying a modest income, bonds might be the way to go. If you’re further away from retirement, where your portfolio can weather larger market swings, you may want to invest in stocks. 
• Bonds offer stability when compared with stocks: Bond prices do change, but that only affects you if you want to buy more or sell what you have. You’re guaranteed income for as long as you hold it, and you’ll get your initial investment back when the bond matures. 
• Stocks offer a greater return on investment in the long term: If you’re willing to take on more risk and ride the volatility inherent in the stock market, you could potentially earn more over time. Bonds pay a modest interest rate corresponding to the market environment in which they originate. 
• Both stocks and bonds can pay income: Bonds pay interest according to their coupon rate, but to find the same type of income, you’ll need to research and find dividend-paying stocks.  

You may also find the professional advice of a financial advisor valuable in deciding which to add to your portfolio at this time. 

Bottom line

Constructing a diversified, well-balanced portfolio can be difficult. When you need help with stocks and bonds, or any number of investments, a financial advisor from Unbiased can help. 

Get matched with a financial advisor via Unbiased today and get all your investment questions answered.