Bonds vs stocks: Which investment is right for you?
Stocks and bonds are the two big asset classes in most portfolios. They are typically viewed as complementing each other in a portfolio. Stocks offer higher returns over the long term, but can be exposed to periods of volatility and sharp declines. Bond returns aren’t as high but deliver fairly stable income. Having both stocks and bonds in a portfolio offers diversification for investors looking to grow long-term wealth.
Bonds and stocks explained
A stock represents a share of ownership in a publicly traded company. It represents a partial ownership claim on a company's earnings and assets. A company's stock value can increase over the long term if a company’s earnings and dividends consistently grow.
Governments and companies issue bonds when they need to raise capital. Investors who buy bonds are providing the issuer a loan in exchange for a regular coupon, or interest payment, and the repayment of the bond’s face value when the bond matures.
What is the difference between bonds and stocks?
Stocks offer the potential for higher returns, but come with higher risk. There are no guaranteed returns.
However, many stocks pay dividends that provide income. While some companies pay dividends, they can be lowered or cut if a company’s earnings come under pressure. Stock investors rank last if a company goes bankrupt.
Bonds offer fixed income payments and are considered safer. Government bonds are typically seen as the lowest risk bonds as they are backed by the government’s ability to generate tax revenue.
Corporate bond holders don’t vote on decisions at a company’s annual general meeting. However, they rank higher than stock investors if a company declares bankruptcy.
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When to buy bonds vs stocks?
Stocks tend to track corporate earnings growth and dividend payments. Buying and holding stocks has been a great way to generate wealth over the long term. ETFs provide a way to invest in the returns of the broader market. Individual stocks require more research and are exposed to risks specific to that company and industry.
A good time to buy cyclical stocks is when the economy is accelerating from a period of slower growth. Stocks like banks, supermarkets, and utilities have lower but more consistent earnings across the cycle.
Bonds offer diversification in a portfolio and provide an income stream. Many investors increase their weighting to bonds as they get older to reduce risk and add income. It’s said bad news is good news for bonds.
Slower economic growth, lower inflation and interest rate cuts would lift bond prices and lower yields. A strongly growing economy with inflation and the threat of higher interest rates would weigh on bond prices and lift yields.
Pros and cons of investing in bonds
Here are the main pros and cons of investing in bonds:
Pros | Cons |
|---|---|
Less risky and not as volatile | Returns are lower than stocks |
Provide a source of income | High inflation can hurt bond prices |
Can diversify a portfolio | The opportunity cost of lower stock exposure |
Pros and cons of investing in stocks
Now compare the other side of investing and review the pros and cons of investing in stocks:
Pros | Cons |
|---|---|
Potential for higher returns | Prices can be volatile and fall sharply |
Dividends can provide income | Dividends can be cut or not paid |
Wide choice of stocks to invest in | Requires time to research |
Types of stocks
There are many types of stocks to discover. See some of the main types below:
- Blue chips are well-established companies like banks, supermarkets and insurers.
- Cyclical stocks are those companies whose earnings are tied to the economic cycle. Cyclical industries include mining, building materials and discretionary retailers.
- Growth stocks are those stocks which are enjoying strong revenue and earnings growth. Technology stocks are growth stocks as they enjoy strong demand for their products. AI-related stocks have rallied on expectations that rising AI demand will drive revenue and earnings growth.
- Value stocks have low earnings multiples and may be unpopular due to poor earnings, an underperforming division or bad management. Value investors hold these stocks in the hope of a rerating if new management is brought in or an underperforming division is sold.
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Performance of bonds vs stocks last 30 years
Stocks have outperformed bonds over the last 30 years as earnings and dividends have increased.
However, stocks have been subjected to periods of extreme volatility and sharp declines such as the 1987 Crash, the collapse of the Dot-com bubble, the Global Financial Crisis and the Covid pandemic.
Bond prices strengthened from the 1980s as central banks reined in inflation. This has pushed yields down for decades. However, resurgent inflation sparked by the pandemic weighed on bond prices and lifted yields higher.
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Is there an advantage to investing in stocks and bonds?
Stocks and bonds can complement each other in a portfolio. The broad stock market produces higher returns but with higher risk. Blue chip stocks tend to be less risky as established companies generally deliver consistent growth in earnings and dividends. Faster growing companies like tech stocks can deliver higher returns but can endure volatility if earnings disappoint. Bonds generate lower returns but can be a less risky source of income. Government bonds are typically viewed as safer than corporate bonds, but corporate bonds can offer higher returns.
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Bonds vs stocks FAQs
Interest rates affect the valuation of bonds by impacting the present value of cash flows from the bond’s coupons, or interest payments. Higher interest rates lower the value of those cash flows. Lower interest rates increase the value of those cash flows.
The global debt market is bigger than equity markets despite the number of U.S. companies with a market cap of over US$1t. Governments have issued a significant amount of debt in recent years to support economies during the pandemic. The Securities Industry and Financial Markets Association estimated global equity markets were valued at US$115t versus US$140t for fixed-income markets in mid-2024.[1]
This article was written by Robert Guy - Senior Markets Writer at Stake.
Disclaimer
The information contained above does not constitute financial product advice nor a recommendation to invest in any of the securities listed. Past performance is not a reliable indicator of future performance. When you invest, your capital is at risk. You should consider your own investment objectives, financial situation and particular needs. The value of your investments can go down as well as up and you may receive back less than your original investment. As always, do your own research and consider seeking appropriate financial advice before investing.
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